A measure of the manufacturing sector hit its highest level since 2004 last month, but consumer spending grew only slightly as households remained cautious on the economic recovery and any increase in jobs, data showed on Monday.

The Institute for Supply Management said its index of national factory activity rose to 58.4 in January from 54.9 in December, beating economists' forecast of a rise to 55.5.

A reading above 50 indicates contraction in the sector. The prices paid component was at its highest since August 2008.

The headline ISM number came in stronger than expected so that is good news, said Jay Mueller, senior portfolio manager at Wells Capital Management in Milwaukee, Wisconsin.

The report's employment component rose slightly, but Mueller said that was not terribly encouraging.

All of the employment numbers are showing that the huge losses in jobs are well behind us but we are not gaining in jobs either. We are just dead in the water.

Stock indices rose on the ISM data while bond prices fell.

A separate Commerce Department report showed U.S. consumer spending rose 0.2 percent in December after increasing by an upwardly revised 0.7 percent in November. It was the third straight monthly gain in spending, which accounts for about two-thirds of the U.S. economy. But it was less than economists had expected, as consumers remained cautious despite higher incomes.

Real disposable income climbed 0.3 percent in December after rising 0.3 percent in November. The rise in income boosted savings to an annual rate of $534.2 billion, the highest level since June. The savings rate rose to 4.8 percent from 4.5 percent the prior month.

For all of 2009, savings rose to a record $502.7 billion.

Commerce Department data also showed the personal consumption expenditures price index, excluding food and energy, rose 1.5 percent in December from a year earlier. The index, which is a key inflation measure monitored by the U.S. Federal Reserve, rose 1.4 percent in November.

It suggests that the Fed still has some time to keep interest rates low. If inflation stays low, the only risk to Fed policy would be higher rates overseas, said Gary Thayer, chief macrostrategist at Wells Fargo Advisors in St. Louis.

The Fed left interest rates near zero last week and repeated a pledge to keep them low for an extended period.

Separate Commerce Department data showed construction spending fell more steeply than expected in December to its lowest level since 2003, hurt by a sharp drop in private residential and state and local government construction.

The Commerce Department said construction spending dropped 1.2 percent to $902.5 billion, falling for a second straight month and bringing the decline for all of last year to a record 12.4 percent.

For the whole of 2009, consumer spending fell 0.4 percent, the largest drop since 1938. Boosting consumer spending is critical to putting the economy on a sustainable recovery path, but a 10 percent unemployment rate is pressuring households.

The economy grew at a 5.7 percent annual pace in the fourth quarter, its fastest clip in six years, driven by a sharp slowdown in the rate at which businesses reduced stocks of unsold goods, the government said on Friday.

Consumer spending slowed to a rate of 2 percent after rising 2.8 percent in the July-September period, the GDP report showed

(Reporting by Steven C. Johnson and Lucia Mutikani; Additional reporting by Ellen Freilich in New York, Editing by Dan Grebler)

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