The number of U.S. workers filing new claims for unemployment benefits fell last week, government data showed on Thursday, but was still at levels indicating the labor market's contraction has yet to hit bottom.

However, a separate report from the Commerce Department showed the country's trade deficit shrank in February to its smallest since November 1999, backing the view that the drop in first-quarter gross domestic product was probably not as steep as the previous quarter's 6.3 percent annual pace of decline.

The Labor Department also said the ranks of unemployed who have claimed more than one week of aid vaulted to yet another record in the last week of March as laid-off workers battled to find jobs amid a recession now in its 16th month.

The small amount of good news is that it appears as though the trend in claims over the last eight weeks has leveled off, but there is nothing here to suggest that the drop in employment is anywhere near the bottom, said Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh.

Wall Street stocks rallied, buoyed by surprisingly robust preliminary results from Wells Fargo, which fueled hopes that stabilization might be returning to the fractured banking sector.

The Dow Jones industrials ended up 3.14 percent at 8,083 points while the S&P 500 jumped 3.81 percent to 856.56. Meanwhile, U.S. government bond prices fell sharply.

Initial claims for state unemployment insurance benefits fell to a seasonally adjusted 654,000 last week from 674,000 the week before, the Labor Department said.

But the number of Americans still on benefit rolls after drawing an initial week of aid jumped to a record 5.84 million in the week ended March 28 from 5.75 million the prior week.

That lifted the insured unemployment rate, which measures the percentage of the insured labor force who are jobless, to 4.4 percent -- matching the highest since April 1983 -- and up from 4.3 percent the previous week.

Continuing claims have hit record highs for 11 consecutive weeks now, underscoring the difficulties of getting new jobs in the recession.

RISING UNEMPLOYMENT A CHALLENGE

Initial claims are being closely watched for clues as to when the downturn, which started in December 2007, might end.

Mounting unemployment is one of the challenges confronting the economy as it is eroding household incomes, which have already been decimated by the collapse in house and stock market prices, limiting their spending ability.

The economy lost 663,000 jobs last month, driving the unemployment rate to 8.5 percent, a fresh 25-year high.

While claims for unemployment benefits remain at lofty levels, recent data have shown some signs of growth sprouting on the battered economy's landscape.

U.S. retailers on Thursday reported smaller-than-expected sales declines in March.

White House economic adviser Lawrence Summers said on Thursday that although the economy was experiencing substantial downdrafts it would end a sense of freefall in the next couple of months as the government's stimulus package and various measures to halt the decline take hold.

I think the sense of a ball falling off the table -- which is what the economy has felt like since the middle of last fall -- I think we can be reasonably confident that that's going to end within the next few months and you will no longer have that sense of freefall, Summers said.

The government has put in place a $787 billion stimulus package of spending and tax cuts while the Federal Reserve has pumped trillions of dollars into the economy.

U.S. TRADE GAP NARROWS

A separate report from the Commerce Department showed the housing-led output contraction is curbing appetite for imports, helping the country's trade gap to shrink by 28.3 percent in February to its smallest since November 1999.

The monthly trade gap totaled $26 billion, down more than $10 billion from the $36.2 billion deficit in January and marking a record seven consecutive months of decline. The percentage drop was the steepest since in October 1996.

Economists said the narrowing trade deficit would add to growth in first-quarter gross domestic product, although the impact would be insufficient to overcome the drag on the economy from housing, inventories and business investment.

This is good news as it will add to growth during the first quarter, said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. With consumer spending holding up better than expected, first-quarter growth could be a lot less negative than initially feared.

The U.S. economy's contraction in the fourth quarter was the sharpest decline since 1982.

U.S. exports of goods and services in February rose 1.6 percent from January, while imports fell 5.1 percent to their lowest since September 2004.

The U.S. trade deficit with China in February shrank to $14.2 billion, a three-year low, from $20.6 billion in January. The February trade gap with Japan narrowed to $2.2 billion, its lowest since December 1984, from $4.3 billion.

Analysts said that was not a good sign for global trade.

In another report, the Labor Department said U.S. import prices rose 0.5 percent in March, advancing for the first time in eight months, as petroleum costs increased 10.5 percent, their fastest increase since November 2007.

Unemployment