Manufacturing activity in the U.S. Mid-Atlantic region hit a two-year high in November, indicating the economic recovery was gaining momentum, while the trend in claims for jobless aid continued downward.

The factory survey from the Philadelphia Federal Reserve Bank on Thursday eased fears of a slowdown in manufacturing after a report this week showed U.S. industrial output barely grew last month as the effect of government stimulus faded.

Manufacturing is leading this recovery. It's the strongest part of the economy. It's not booming but it's probably the first place where you'll see job growth, said Christopher Low, chief economist at FTN Financial in New York.

The Philadelphia Fed's business activity index, one of the earliest monthly indicators of the health of U.S. manufacturing, rose to 16.7 last month, the highest since June 2007. It was the fourth straight monthly increase.

Financial markets had expected the index to improve to 12 from October's 11.5. A reading above zero indicates growth.

Separately, the Labor Department said initial claims for state unemployment benefits were flat at 505,000 last week, but a four-week moving average of claims, a better indicator of underlying trends, dropped to its lowest in almost a year.

A third report gauging the economy's prospects rose for a seventh straight month in October, reaching a two-year high.

U.S. stock prices were unmoved by the data as Bank of America-Merrill Lynch cut its 2010 growth forecasts for the semiconductor sector, pressuring technology shares. Stocks fell for a second straight day after hitting 13-month highs this week.

FED ON HOLD

The U.S. economy resumed growth in the last quarter, driven largely by government stimulus. There are fears recovery will be sluggish because of rising unemployment. The jobless rate hit 10.2 percent last month, its highest in 26-1/2 years.

High unemployment and excess industrial capacity have led the Federal Reserve -- the U.S. central bank -- to pledge to hold interest rates near zero for an extended period.

U.S. fixed mortgage rates sank to or near record lows last week, home funding company Freddie Mac said on Thursday, adding incentive for refinancing and home purchases.

U.S. Treasury Secretary Geithner told Congress' Joint Economic Committee he expected growth both in the fourth quarter and in 2010.

But as we press forward toward recovery, there is still much work to do not only to ensure that many more Americans see the tangible benefits of recovery, but also to help ensure that Americans are never again forced to suffer the consequences of a preventable economic collapse, he said.

Given high unemployment, more Americans are finding it difficult to keep up with mortgage payments. Mortgage delinquency rates and the percentage of loans that entered the foreclosure process hit record highs in the third quarter, a report showed.

But the economic data on Thursday hinted the labor market was slowly moving toward stability. The employment index of the Philadelphia survey was at its best level since May 2008 as new orders scaled a more than two-year high.

The Labor Department report showed the four-week moving average for new jobless benefit claims last week fell to its lowest since November last year in the 11th straight decline.

Also encouraging, the number of workers still collecting benefits after an initial week of aid dropped to its lowest since March, although some of the decline may reflect workers exhausting their benefits. So-called continuing claims have fallen from a peak of 6.9 million in June.

New applications for unemployment benefits have dropped significantly from March's lofty levels, but remain above the 400,000 mark that analysts say would signal payrolls growth.

Analysts noted that the jobless claims data covered the survey period for the government's closely watched monthly report on employment. They said the report suggested job losses would be smaller in November than in October, when payrolls fell 190,000.

The picture for the labor market is of a very, very slow improvement. But clearly in terms of the unemployment rate, we're likely to continue to see deterioration, said Anna Piretti, a senior economist at BNP Paribas in New York.

(Additional reporting by Chris Reese in New York; Editing by James Dalgleish)

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