WASHINGTON - A bigger-than-expected rise in the number of U.S. workers filing new claims for jobless aid last week signaled the labor market remained fragile, even as a measure of economic prospects hit a two-year high last month.

Initial claims for state jobless insurance increased 11,000 to 531,000 last week, the Labor Department said on Thursday, after falling for two consecutive weeks. Financial markets had expected new claims to come in at just 515,000.

Separately, the Conference Board said its index of leading economic indicators rose 1 percent to 103.5, the highest level since October 2007. But optimism over the robust increase was tempered by a report showing that home prices fell 0.3 percent in August.

The data confirm an overall picture of a gradual economic improvement, but we are not seeing it in the commercial real estate and jobs markets, said Larry Milstein, head of government and agency trading at R.W. Pressprich & Co in New York.

U.S. stocks were trading mixed as investors digested the economic data and strong quarterly earnings from the world's largest hamburger chain McDonald's Corp and diversified manufacturer 3M Co.

While data and earnings reports from some companies strongly indicate the economy started growing again in the July-September period after four quarters of decline, persistently high unemployment has raised questions about the recovery's durability.

White House economic adviser Lawrence Summers told Reuters in an interview on Wednesday that the economy was set for a recovery, but he cautioned that the growth pace might be moderate and the job market would not revive immediately.

Analysts reckon the Federal Reserve, which is holding overnight interest rates near zero, will want to see labor markets beginning to heal before it withdraws its support for the economy.

Boston Federal Reserve Bank President Eric Rosengren acknowledged on Thursday that the economy would grow reasonably in the second half of this year, but said the U.S. central bank needed to see more progress before taking some of its economic support away.

SOME HOPEFUL SIGNS ON JOBS

The U.S. unemployment rate rose to a 26-year high of 9.8 percent in September and is expected to increase well into 2010.

Still, the pace of job losses has moderated considerably from early this year. The four-week moving average for new jobless claims fell by 750 to 532,250 last week, the lowest level since mid-January, the Labor Department said.

It was the seventh straight week of decline in the four-week average, which is considered a better gauge of underlying trends as it irons out week-to-week volatility.

There were more encouraging signs, with the number of people collecting long-term unemployment benefits dropping 98,000 to 5.92 million in the week ended October 10. That was the lowest level since March and it was the first time that continuing claims fell below the 6 million mark since April.

This measure has trended lower for five straight weeks. Analysts view this steady decline as an indication that unemployment might be close to peaking, but it could also reflect that many jobless workers have exhausted their unemployment benefits.

Even as we anticipate that the economy likely grew in the third quarter, the excess slack in the system and employers' hesitance to ramp up hiring appear likely to weigh on the labor markets for some time, said Jim Baird, chief strategist at Plante Moran Financial Advisors in Kalamazoo, Michigan.

The insured unemployment rate, which measures the percentage of the insured labor force that is jobless, edged down to 4.5 percent in the week ended October 10 from 4.6 percent the prior week, the department said.

Another hopeful sign was provided by a Labor Department report that showed the number of mass layoffs, defined as job cuts involving at least 50 people from a single employer, fell by 129 to 2,561 last month.

(Additional reporting by Emily Kaiser and Tim Ahmann in Washington and Richard Leong in New York; Editing by Andrea Ricci)

Unemployment