Consumers stepped up their spending in November and grew more optimistic this month, unexpectedly strong data showed on Friday, raising hopes a self-sustaining economic recovery was starting to unfold.

A slew of data this week has suggested the recovery is gaining momentum, pulling further away from the devastating recession that pushed unemployment to quarter-century highs and raising hopes the economy can return to normal growth as massive government support starts to fade.

The recovery looks to be more on track. The combination of improvements in the labor market and consumer spending is a strong signal that we're not at this point entering into a double-dip scenario, said Torsten Slok, a senior economist at Deutsche Bank in New York.

The economy snapped four straight quarters of decline by growing at a 2.8 percent annual rate in the third quarter. Economists said the latest data suggested growth in the fourth quarter could come in at 4 percent or higher.

We are not out of the woods yet but there is definitive improvement and there is a somewhat brighter outlook for the consumer than there was a couple of months ago, said Kevin Flanagan, a fixed income strategy with Morgan Stanley in Purchase, New York.

Retail sales rose 1.3 percent last month, the largest advance since August, the Commerce Department said. It was the second straight monthly gain and easily beat market expectations for a 0.7 percent increase.

The strong sales data was seen boding well for the holiday shopping season, a view bolstered by a separate report that showed consumer sentiment improved in early December on signs of stabilization in the labor market.

The Reuters/University of Michigan Surveys of Consumers' preliminary index of sentiment for December rose to 73.4, just a touch below the year's high set in September, from 67.4 in November. Economists had expected a reading of 68.5.

RATE HIKE SPECULATION

The upbeat data fanned speculation that the Federal Reserve could be forced to start thinking about raising interest rates sooner than had been expected.

That lifted the U.S. dollar to a two-month high against the euro, while the prospect of tighter monetary policy pushed prices for U.S. government debt lower. On Wall Street, the blue-chip Dow Jones industrial average and the Standard & Poor's 500 Index ended higher.

The U.S. central bank has committed to keep borrowing costs near zero for an extended period. Policymakers will assess the strength of the recovery, which has been built on low rates and government spending, at a meeting on Tuesday and Wednesday.

There is significant upside risk that we will have a stronger recovery than what the Fed and what the consensus is expecting. That's probably causing headaches ... the thing that's at the center of their radar screen is when should we remove the 'extended period' language, said Slok.

With the labor market starting to stabilize and household wealth rising, there is growing optimism that consumer spending will continue to gain strength. Compared with November last year, overall retail sales were up 1.9 percent, the first year-on-year gain since August 2008.

For a graphic comparing retail sales to the rise in retail stocks, please doubleclick on http://link.reuters.com/puq46g

WIDESPREAD SALES GAIN

Sales in November were boosted by strong receipts from gasoline stations, increased purchases of motor vehicles and parts, building materials and electronic goods, among others.

Despite slightly lower gasoline prices at the end of November from the end of October, sales at service stations surged 6 percent, the largest increase since June.

The numbers were a pleasant surprise. Consumers are starting to spend a little more freely than they have been and that is going to be an important source of sustainable growth, said David Resler, chief economist at Nomura Securities International in New York.

Excluding motor vehicles and parts, retail sales rose 1.2 percent, the largest increase since January, after being flat in October. Economists had expected a 0.4 percent gain.

So-called core retail sales, which exclude autos, gasoline and building materials, rose 0.6 percent, a fifth straight monthly advance.

Sales of building materials made their biggest gain since April 2008 and purchases of electronics and appliances were the most in 10 months.

Bolstering the chances of a sturdy growth pace in the fourth quarter, U.S. business inventories unexpectedly rose in October for the first time in more than a year, a second report from the Commerce Department showed.

The story is a shift from slower (inventory) liquidation to accumulation in anticipation of rising demand, said Tony Crescenzi, a portfolio manager with Pacific Investment Management Co in Newport Beach, California.

Inventory investment will lead to further increases in industrial output that in the context of recent productivity trends will translate into stabilization of the labor market.

(Additional reporting by Richard Leong and Chris Reese in New York)

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