The number of U.S. 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, pointing to a continued expansion in the economy.

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

The labor market has lagged the manufacturing-led economic recovery from the worst downturn since the 1930s. Job growth is key to sustaining that recovery when the impetus from rebuilding of inventories disappears later this year.

This is unmitigated good news for the manufacturing sector, which is good news for the progress of the general recovery, Pierre Ellis, a senior economist at Decision Economics in New York, said of the sturdy manufacturing report.

Initial claims for state unemployment benefits slipped 6,000 to a seasonally adjusted 439,000, the Labor Department said. Markets had expected claims to dip to 440,000. The data has no impact on Friday's job figures because it falls outside the survey period for the March employment report.

The four-week moving average of new claims dropped 6,750 to 447,250, the lowest level since September 2008.

Separately, the Institute for Supply Management's index of national factory activity rose to 59.6, the highest since July 2004, from 56.5 in February. That was above market forecasts for 57.0.

A reading above 50 indicates expansion in manufacturing. However, a measure of employment slipped slightly.

U.S. stock indexes extended gains on the manufacturing report, while Treasury debt prices deepened losses. The U.S. dollar rose against the yen and the euro.

A Reuters survey forecast 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. Payrolls fell 36,000 in February.

The median projection from the 20 economists who have forecast payrolls most accurately over the past year predicts 200,000 jobs were created in March.

UNEMPLOYMENT RATE TO STAY HIGH

Treasury Secretary Timothy Geithner 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. The jobless rate 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.

While claims for unemployment benefits have resumed their downward trend after stalling early this year, they are still above the 400,000 threshold that analysts say will signal labor market stability. Many analysts still see job growth, however.

New claims tend to focus more on the job loss than the job hiring side and it looks like this cycle may see nonfarm payrolls turn positive near current claims levels, said Alan Ruskin, head of currency strategy at RBS Global Banking & Markets in Stamford, Connecticut.

The number of people still receiving benefits after an initial week of aid fell in the week ended March 20 to its lowest since December 2008. The number of people on extended employment benefits rose, however.

The insured unemployment rate, which measures the percentage of the insured labor force that is jobless, was steady at 3.6 percent for a fifth week.

Separately, planned layoffs at U.S. firms rose last month, although planned job cuts for the first quarter were down sharply from a year ago, outplacement consultants Challenger, Gray & Christmas Inc said.

While areas such as manufacturing are thriving, continued weakness in the construction sector is holding back the economy's growth potential.

U.S. construction spending fell for a fourth straight month during 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.

Overall construction spending fell 1.3 percent to a seasonally adjusted annual rate of $846.23 billion following a revised 1.4 percent decline in January that previously was reported as a 0.6 percent decrease.

The February drop exceeded the 1 percent decline that economists surveyed by Reuters had forecast.

(Reporting by Lucia Mutikani, Glenn Somerville and Steven C Johnson; Editing by Chizu Nomiyama and Padraic Cassidy)

Timothy geithner Unemployment Fall Manufacturing