The number of Americans filing new claims for jobless benefits fell to a 3-1/2-year low last week and factory activity in parts of the Northeast gained speed in December, suggesting a further strengthening of the economic recovery.

While other data on Thursday showed industrial output shrank for the first time in seven months in November, much of the decline came from auto production, which analysts said was held back by temporary supply disruptions.

It looks like we have just hit a clear patch on the road to recovery, where things are going to speed up a little bit, said Mark Vitner, a senior economist at Wells Fargo Securities in Charlotte, North Carolina.

The fairly upbeat data helped investors on Wall Street to put aside their worries about the European debt crisis and buy stocks. U.S. stocks ended slightly higher after three straight days of losses.

Prices for U.S. Treasury debt were flat to marginally lower, while the dollar weakened against a basket of currencies.

Although growth is quickening from the third quarter's 2 percent annual rate, analysts caution that troubles in debt-stricken Europe pose a major risk to the U.S. economy. The fourth quarter growth pace is expected to top 3 percent.

Much of the rest of the global economy is already weakening, with the euro zone expected to slip into recession.

The U.S. economy also faces a risk that lawmakers will fail to extend a payroll tax cut and emergency jobless benefits that expire at year end, which would dent the expansion in 2012.

For now, however, it continues to show resilience.

Initial claims for state unemployment benefits dropped 19,000 to 366,000, the lowest since May 2008, the Labor Department said. That follows on the heels of a report earlier this month that showed the jobless rate hit a 2-1/2-year low of 8.6 percent in November.

REGIONAL FACTORY ACTIVITY PICKS UP

The economy's firming tone was also emphasized by data showing an acceleration in factory activity in New York state and the Mid-Atlantic region this month.

The Philadelphia Federal Reserve Bank said its index of business conditions rose to its highest since March as new orders surged. A separate report showed business activity in New York state at its highest since May, with a strong rebound in new orders and an improvement in hiring.

But the Fed's industrial production report took off some of the shine from the two regional factory surveys. Output at the nation's mines, factories and refineries dropped 0.2 percent in November after rising 0.7 percent in October.

The decline was led by a 0.4 percent drop in factory output, which reflected a 3.4 percent slump in motor vehicle production.

Economists, however, blamed a scarcity of auto parts from flood-ravaged Thailand for the weakness. They said it also likely weighed on production of high-technology goods, which were down sharply for a third month running.

We are not worried about the health of the manufacturing sector, said Michelle Girard, a senior economist at RBS in Stamford, Connecticut.

Inventories are lean and firms will likely need to restock after a decent holiday season. Automakers also plan healthy production increases in the first quarter.

FedEx Corp provided a further signal the economy was gaining momentum, saying demand for residential delivery services was rising with healthy growth in online shopping.

Honeywell International, the maker of products ranging from cockpit electronics to control systems for large buildings, also struck an upbeat note on the economy and forecast strong sales growth next year.

Another report from the Labor Department showed wholesale prices rose 0.3 percent last month, reversing October's 0.3 percent fall, as food prices climbed 1 percent.

Excluding food and energy, producer prices were up a mild 0.1 percent last month after being flat in October, suggesting little buildup in broad inflationary pressure.

(Additional reporting by Pedro Nicolaci da Costa in Washington and Leah Schnurr in New York; Editing by James Dalgleish)

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