New claims for unemployment benefits fell last week to their lowest level in more than 2-1/2 years, signaling an acceleration in job creation could be taking shape.

The labor market outlook was also enhanced by another report on Thursday showing a gauge of employment in the dominant services sector rose to a near five-year high in February. Other data also confirmed a slowdown in business productivity that could herald stepped-up hiring.

Initial claims for state jobless benefits dropped 20,000 to 368,000, the lowest since May 2008, the Labor Department said. Economists had forecast claims rising to 398,000.

There can be no denial that a strengthening in labor market conditions is under way, as layoffs have dropped sharply since the beginning of the year, said Jim Baird, a partner at Plante Moran Financial Advisors in Kalamazoo, Michigan.

Coupled with increasing consumer demand, this should translate to a faster pace of job creation in time.

The data, together with a drop in oil prices as the Arab League considered a peace plan for strife-torn Libya, lifted stocks on Wall Street.

Prices for safe-haven U.S. government debt fell, while the dollar slipped against the euro after European Central Bank President Jean-Claude Trichet raised expectations of a near-term interest rate increase.

The claims data falls outside the survey period for the government's closely watched employment report for February due for release on Friday.

Nonfarm payrolls probably increased 185,000 after snowstorms held growth to a paltry 36,000 jobs in January, according to a Reuters survey. The survey was conducted before data on Monday that showed strong factory hiring, which prompted some economists to rethink their forecasts.

A separate report showed growth in the country's services touched a fresh 5-1/2 year high in February. The Institute for Supply Management's index of national non-manufacturing activity rose to 59.7, the highest since August 2005, from 59.4 in January.

A reading above 50 indicates an expansion in the services sector, which accounts for about 80 percent of the U.S. economy. A measure of employment in the sector hit its highest level since April 2006.

Declining claims suggest the economic recovery is gaining traction and fewer layoffs should help it weather crude oil prices that have topped $100 a barrel on political unrest in the Middle East and North Africa.

Reports from U.S. retailers on Wednesday suggested consumers so far were withstanding a related jump in gasoline prices. Costco Wholesale Club , teen apparel retailer Zumiez and other chains reported February sales results that beat Wall Street's expectations.

CLAIMS BELOW KEY LEVEL

Weekly jobless claims have now held below the 400,000 threshold for a second straight week. Claims below that level are widely viewed as signaling strong jobs growth and economists believe it is only a matter of time before this is reflected in the payrolls numbers.

A Labor Department official said there was nothing unusual in the state level data, adding that no states were estimated.

The four-week moving average of unemployment claims -- a better measure of underlying trends -- dropped 12,750 to 388,500 last week, the lowest since July 2008.

In a second report, the department said nonfarm productivity increased at an unrevised 2.6 percent annual rate in the fourth quarter, in line with economists' expectations.

Productivity, a measure of hourly output per worker, grew at a 2.3 percent pace in the third quarter.

Productivity grew rapidly as the economy emerged from the worst recession since the Great Depression of the 1930s, peaking at an 8.9 percent rate in the second quarter of 2009 as businesses slashed costs by relying on a small pool of workers.

The pace is slowing, which economists say will compel businesses to soon add more workers to expand production.

They are not going to be able to squeeze as much out of their current workforce as they were in the past, said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania.

Unit labor costs, a gauge of potential inflation pressures closely watched by the Federal Reserve, fell at an unrevised 0.6 percent rate. Labor costs edged up 0.1 percent rate in the third quarter.

Depressed unit labor costs will help to keep inflation pressures contained at a time when rising oil prices are pushing up input costs for many businesses.

(Reporting by Lucia Mutikani, Editing by Andrea Ricci)

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