The number of U.S. workers filing new claims for jobless benefits fell to the lowest level since January, but the seasonally adjusted data was distorted by an unusual pattern of layoffs in the automotive industry.

Economists watch the labor market closely for signs that the impact of the most severe recession in decades is fading, and worry that failure to curb unemployment that has spiked to 9.5 percent will thwart official efforts to stimulate growth.

The Labor Department tries to anticipate seasonal changes in jobless claims, such as the auto industry usually closing plants in July to retool for the new model year. However, the bankruptcies of U.S. automakers has distorted the normal pattern of plant closings.

Major U.S. stock indexes rose on the jobs data, but later turned mixed. U.S. government debt prices and the dollar were lower.

A separate report on Thursday showed wholesale inventories declined again in May, but at a slower pace than in the previous month, keeping alive hopes for a rebound in stock-building that could aid growth in the remainder of 2009.

Economists say large inventory liquidations will reduce economic growth in the second quarter, but lay the foundation for a recovery as firms replenish depleted stocks in anticipation that sales will pick up.

However, weak June retail sales reports from a number of big stores on Thursday signaled that shoppers remain cautious. The state of the jobs market will be a crucial factor in determining what happens to consumer demand.

The Labor Department said that initial claims for state unemployment insurance fell 52,000, the largest drop since December, to a much lower-than-expected seasonally adjusted 565,000 in the week ended July 4, from 617,000 the prior week.

It was the lowest reading since January. Analysts polled by Reuters had forecast claims to drop to 605,000 from a previously reported 614,000.

CONTINUED CLAIMS RECORD

However, in a sign of ongoing employment weakness, continued claims of people still on jobless aid after an initial week of benefits rose by 159,000 to a record 6.88 million in the week ending June 27, the latest for which data is available.

The move higher in continuing claims is particularly discouraging given that the stabilization and slight move down in this series over the prior few weeks was one of the more uplifting pieces of data coming out of the labor market recently, Michael Feroli, an economist at JP Morgan Chase, wrote in a note to clients.

In addition, the new claims data appears to have been significantly distorted by seasonal factors.

Ignore this number. Our old and unpredictable friend the annual auto shutdowns has struck again, rendering the data meaningless this week and for the next few weeks, said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

A Labor Department official said there had been far fewer automotive and other manufacturing layoffs last week than anticipated on the basis of past experience in July, when many plants are commonly idled.

The seasonal factors the department uses to adjust the data to provide a better sense of the underlying trend had expected a large increase in claims last week. Actual claims in fact rose by a much smaller amount, which when seasonally adjusted, generated a large fall.

A number of states said that auto sector layoffs apparently had already happened, reflecting closures in the battered U.S. automotive industry, while other states said they did not get the layoffs they had anticipated.

The 4-week moving average for new claims declined by 10,000 to 606,000, the lowest reading since February. This measure is closely watched because it irons out weekly volatility, and it has now declined in four out of the last five weeks.

GLOOMY RETAILERS, INVENTORIES SHRINK

The news from the retail sector was gloomy, with many U.S. apparel retailers and warehouse club stores reporting that sales fell in June including Costco Wholesale Corp , which saw a 6 percent drop in sales at stores open a year.

A separate report from the Commerce Department showed that U.S. wholesale inventories shrank for the ninth month in a row in May to $402.24 billion, the lowest level since August 2007.

The 0.8 percent drop was smaller than the 1 percent decline analysts polled by Reuters had expected.

Sales at wholesalers rose 0.2 percent, beating analysts' expectations that they would be unchanged and pushing the inventory-to-sales ratio, a measure of how long it would take to deplete stocks at the current sales pace, down to 1.29 months' worth from April's 1.31 months.

That was the lowest since a matching ratio in November and economists think that this trend will be reversed in the coming months as merchants rebuild stocks.

This will give production a boost, although economists say there will only be a lasting addition to growth if employment picks up consumers feel confident enough to resume spending.

We have a positive growth forecast for the third quarter and it's very hard not to get a better outcome than the last three quarters, given the inventory cycle, said Mike Englund, an economist at Action Economics. People will be pretty worried if the only addition to production is coming through a bump in inventories.

(Additional reporting by Aarthi Sivaram and Ryan Vlastelica in New York, Lisa Lambert in Washington; Editing by Neil Stempleman)

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