The number of workers filing new claims for jobless aid fell last week and factory activity in March hit its highest level in more than 5-1/2 years, strengthening hopes for continued economic growth without government support.

Thursday's data came a day before the release of the government's closely watched employment report for March, which is expected to show nonfarm payrolls grew for only the second time since the economy fell into recession in December 2007.

Manufacturing has led the economy out of its deepest recession since the 1930s, but the labor market has lagged. Job growth is essential to maintain expansion when the impetus from a rebuilding of inventories disappears later this year.

The data suggest that the economic recovery is reaching a self-sustaining stage, which means it's less prone to setbacks. If we wait a couple more months we are going to find that this recovery is very robust, said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.

Initial claims for state unemployment benefits slipped 6,000 to 439,000 in the week ended March 27, the Labor Department said.

The data, which mirrored market expectations, offered few clear hints on Friday's job figures because the week covered is not part of the survey period for the March employment report.

The four-week moving average of new claims, considered a better measure of underlying labor market trends, fell 6,750 to 447,250, the lowest level since September 2008, when the financial crisis exploded.

Separately, the Institute for Supply Management, an industry group, said its index of U.S. factory activity rose to a reading of 59.6, the highest since July 2004, from 56.5 in February. Markets were expecting a reading of 57.0.

A reading above 50 indicates expansion in manufacturing.

An employment sub-index slipped slightly, but analysts said the surge in production would eventually lead to hiring.

Chris Low, chief economist at FTN Financial in New York, said the data suggested the Federal Reserve would likely need to start bumping interest rates higher late in the year.

This is the kind of strength in manufacturing consistent with economic growth strong enough to create enough jobs to allow the Fed to raise rates in the fourth quarter if it continues, Low said.

U.S. benchmark rates have been near zero percent since December 2008 and the central bank has pledged to keep them ultra-low while it monitors the strength of the recovery. Optimism in the economy was also reflected in the automotive sales released on Thursday, with sales up sharply.

FAIRLY UPBEAT DATA

The update economic data drove up U.S. stocks on Thursday, with the main indexes posting a fifth straight week of gains. The stock market will be closed on Friday for the Good Friday holiday.

The data also helped drive the U.S. dollar to a seven-month high against the yen, while U.S. government debt prices fell as investors' risk appetite rose.

Economists expect the jobs report on Friday to show payrolls increased 190,000 last month, boosted by hiring for the 2010 U.S. census and a bounce-back from February's weather-related losses, a Reuters survey found. Payrolls fell 36,000 in February.

The median projection from the 20 economists who have forecast payrolls most accurately over the past year is for the creation of 200,000 jobs in March.

Treasury Secretary Timothy Geithner took a cautious view on the labor market a day ahead of the payrolls report. He told NBC's Today show that while the economy was going to start creating jobs again, the unemployment rate would remain high for some time. It has held at 9.7 percent for two months.

The unemployment rate is still terribly high, and it's going to stay unacceptably high for a long period of time, Geithner said.

The number of people still receiving jobless benefits after an initial week of aid fell in the week ended March 20 -- the latest week for which this data is available -- to its lowest level since December 2008. However, the number of people on extended employment benefits rose.

And even amid hopes that employers added jobs in March, planned job cuts at U.S. firms rose last month, outplacement consultants Challenger, Gray & Christmas Inc said. Planned layoffs for the first quarter, however, were down sharply from a year ago.

While manufacturing is thriving, the U.S. economy is still feeling pressure from continued weakness in the construction sector.

Construction spending fell for a fourth straight month in February to the slowest rate in nearly 7-1/2 years as activity softened in every major sector from homebuilding to public construction projects, a Commerce Department report showed.

The United States has not been alone in notching manufacturing gains, boosted by a swing in the inventory cycle as companies seek to restock warehouses and by a pick-up in global trade.

Manufacturing in Britain expanded at its fastest pace since 1994 in March, and China's vast industrial sector also grew last month. In Germany, factory activity grew at a rate not seen in almost 10 years in March, while France's manufacturing sector expanded at its fastest pace since November 2006.

(Additional reporting by Glenn Somerville and Andy Sullivan in Washington and Steven C Johnson in New York; Editing by Andrew Hay, James Dalgleish and Leslie Adler)

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