New claims for jobless benefits fell to their lowest level in nearly two years, but a sharp pullback in manufacturing activity in New York state added to evidence of a slowing economic recovery.

Initial claims for state unemployment benefits dropped 29,000 to a seasonally adjusted 429,000 last week as seasonal layoffs at factories eased, the Labor Department said on Thursday.

Analysts polled by Reuters had expected claims to fall to 450,000 from the previously reported 454,000, which was revised up to 458,000 in Thursday's report.

Separately, the New York Federal Reserve Bank's Empire State general business conditions index fell almost 15 points to 5.08 in July, the lowest since December 2009.

U.S. stock index futures cut gains on the manufacturing data, while Treasury debt prices trimmed losses. The U.S. dollar fell versus yen.

Overall, U.S. fundamentals are making the U.S. less attractive to investors and reinforcing the idea that investors want to move on from the fiscal problems in Europe, said Kathy Lien, director of currency research at GFT Forex in New York.

In a third report, U.S. producer prices fell for a third straight month in June on weak food and energy costs, which should help the Federal Reserve maintain its low interest rate policy well into 2011 to nurse the sputtering recovery.

The weak labor market, characterized by a 9.5 percent unemployment rate, is holding back the economy's recovery from the most painful recession since the 1930s.

Lack of income has caused consumer spending to turn sluggish in the past months, prompting economists to trim their growth forecasts for the second quarter.

New claims for jobless benefits normally rise this time of the year as manufacturers, including automakers, implement annual shut downs. However, General Motors is keeping the majority of its plants open during the annual summer retooling shutdown to meet demand for some models.

A Labor Department official said layoffs that are normally scheduled for this time of the year did not appear to have materialized.

This not just a General Motors thing, we are seeing this across a swathe of states, we did not see an increase in claims as we would normally, the official said.

Last week, the four-week moving average of new jobless claims, considered a better measure of underlying labor market trends, fell 11,750 to 455,250.

Federal Reserve policymakers, according to minutes of their June 22-23 meeting released on Wednesday, felt they should be ready to consider additional steps to boost the economy if the already weak outlook worsened.

Last month, energy prices fell 0.5 percent after declining 1.5 percent in May. Gasoline prices dropped 1.6 percent, while food costs tumbled 2.2 percent - the largest decline since April 2002.

Stripping out volatile food and energy costs, core producer prices edged up 0.1 percent last month, matching expectations, after increasing 0.2 percent in May.

A combination of weak energy prices and low rates of resource utilization are keeping inflation subdued.

With domestic demand retreating and unemployment still stubbornly high, many economists do not expect the Fed to lift overnight interest rates, currently near zero, until at least the second half of next year.

Last month, core PPI was lifted by a 2.5 percent surge in the cost of heavy motor trucks, which was the largest increase since April 2007, the Labor Department said.

In the 12 months to June, the core producer price index rose 1.1 percent, in line with market expectations, following a 1.3 percent increase in May.

(Reporting by Lucia Mutikani; Editing by Neil Stempleman)

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