The U.S. manufacturing sector grew faster than expected in August, but private employers unexpectedly cut jobs, showing the economic recovery still faces headwinds.

The 13th straight month of manufacturing expansion calmed fears that the U.S. economy may fall back into recession, but the drop in employment and a slump in July construction spending to a 10-year low kept concerns about slow economic growth alive.

Our expectation is that we don't have an economic double-dip, though we recognize that the risks of something like that are a lot higher now that we're closer to zero on the growth rate, said Jason Pride, director of investment strategy at Glenmede Investment and Wealth Management in Philadelphia.

We're in the middle of what is typically a growth scare, where the economic cycle slows down after an initial run up as stimulus fades and we transition from stimulus to having the economy standing on its own, he said.

The Institute for Supply Management said its index of national factory activity rose to 56.3 from 55.5 in July. Economists had forecast a fall in the index to 53.0. A reading above 50 indicates expansion in the sector.

In a separate report, the private sector unexpectedly cut 10,000 jobs in August compared to a gain of 37,000 in July, ADP Employer Services said.

U.S. stocks rallied more than 2 percent, while prices for safe-haven U.S. government debt fell. The U.S. dollar fell against the euro while high-yielding currencies such as the Australian dollar rose as investors rediscovered an appetite for risk.

MANUFACTURING GROWING, BUT JOBS LAG

The U.S. government is expected to report on Friday that total payrolls dropped by 100,000 in August, the third straight month of job declines, while private sector employment increased only 41,000, according to a Reuters survey.

Last month, second quarter gross domestic product data showed the economic recovery slowing as the boost from an $814 billion government stimulus package and business inventories rebuilding faded.

But manufacturing, which has been leading the recovery, is still showing some strength and has expanded every month since August 2009.

Over the first half of the year we saw much stronger growth on average, now we're seeing things plateau, but certainly there's no sign of a double dip in manufacturing, said Norbert Ore, chairman of the ISM manufacturing business survey committee.

The manufacturing sector added jobs in August, according to ISM, though Ore said the pace of hiring remains fairly slow.

We lost a lot of jobs in the manufacturing sector and replacing them is very slow, he said.

The departing chairperson of the White House's Council of Economic Advisors, Christina Romer, called on Wednesday for further steps to stimulate the U.S. economy, saying high budget deficits should not be an excuse for allowing the unemployed to suffer.

We have tools that would bring unemployment down without worsening our long-run fiscal outlook, if we can only find the will and the wisdom to use them, Romer said in excerpts from a speech she will deliver later at the National Press Club.

The ADP report showing a cut in private payrolls contrasted with another report showing the number of planned layoffs at U.S. firms fell 17 percent in August from the prior month.

Employers announced 34,768 planned job cuts last month, down from 41,676 in July, outplacement consultancy Challenger, Gray & Christmas, Inc. said.

It was the first month-on-month decline in planned layoffs since April and the lowest level since June 2000.

Though plans for layoffs are down, however, that still might not mean that hiring is at the top of companies' agenda.

I think it's pretty clear what's happened is firing has stopped -- we're not losing jobs at the disheartening pace we were a year-and-a-half ago -- but widespread hiring has really not begun, said Joel Prakken, chairman of Macroeconomic Advisers LLC.

Economists often refer to the ADP report as a guide to the official U.S. Labor Department payrolls numbers due on Friday, though it is not always accurate in predicting the outcome.

In any case, the grim quality of the private sector jobs data is likely to rekindle debate on how to get more people back to work, with the U.S. unemployment rate still high at 9.5 percent and expected to rise to 9.6 percent with Friday's report for August.

A third report on Wednesday showed construction spending dropped 1.0 percent to an annual rate of $805.2 billion, the lowest since July 2000. June's construction outlays were revised down to show a 0.8 percent fall, instead of the previously reported 0.1 percent gain.

In other data on Wednesday, U.S. mortgage applications for home purchasing and refinancing increased last week as interest rates hit a new low, a glimmer of hope for a housing market that has weakened again after the expiry of a government tax credit for home buyers.

(Additional reporting by Steven C Johnson, Leah Schnurr, Edward Krudy and Ryan Vlastelica in New York; Editing by Kenneth Barry)

Manufacturing