An index of the U.S. services sector shrank in November to its lowest since July, according to a report released on Thursday that shocked economists who had forecast a recovery from recession was picking up steam.

That news offset a report showing new applications for U.S. jobless benefits unexpectedly fell last week to the lowest in more than 14 months, suggesting the battered labor market was edging toward stability.

The White House said after the report it has seen signs the U.S. unemployment rate, which will be updated for November on Friday, might tick upward.

The Institute for Supply Management said its services index shrank to 48.7 from 50.6 in October, well below the 51.5 median forecast in a Reuters poll. A reading above 50 indicates expansion.

It's a disappointing number, Gary Thayer, chief macrostrategist at Wells Fargo Advisors in St. Louis. Manufacturing is being helped by low inventories but the service sector is taking longer to get a turnaround started.

The services sector, which represents about 80 percent of U.S. economic activity, includes businesses such as banks, airlines, hotels and restaurants.

(For a graphic on the ISM report see http://link.reuters.com/myf84g)

U.S. government bond prices fell on Thursday, sending yields to one-week highs, partially on signs of improvement in the job market.

All three major U.S. stock indexes <.DJI> <.SPX> <.IXIC> dropped on the day while the dollar fell against the euro but gained against the yen.

ALL EYES ON THE JOB MARKET

The weak labor market, which is seen as the biggest threat to recovery from the worst recession since the 1930s, is being closely watched. The U.S. November nonfarm payrolls report will be released on Friday.

Initial claims for state unemployment aid fell to 457,000 from 462,000 the previous week, the U.S. Labor Department said on Thursday, for a fifth straight weekly drop. Analysts polled by Reuters had forecast claims would rise to 480,000.

Now we have had two weeks in a row clearly below 500,000. That is very encouraging. In order to move from net loss of jobs into positive payrolls territory, we need to get down to about 400,000 in claims. We are halfway there, said Jay Mueller, senior portfolio manager at Wells Capital Management in Milwaukee.

The government data on Friday is expected to show that job losses moderated sharply in November and probably will support views that the shrinkage in payrolls is in its final stages.

Analysts polled by Reuters forecast U.S. employers shed 130,000 jobs last month after cutting 190,000 in October.

President Barack Obama on Thursday called on corporate America to help tackle the nation's highest unemployment in 26 years and dismissed skeptics who have doubted his efforts to boost employment.

Obama hosted business and labor leaders at the White House to brainstorm how to lift employment creation.

In yet more evidence of labor market weakness, U.S. motorcycle maker Harley-Davidson Inc said on Thursday it had ratified a new contract with the machinists' union representing employees at its largest factory that involves job cuts of almost 50 percent.

AN ECONOMY SLOWLY ON THE MEND

U.S. retail sales were also eyed for clues on the economy's health.

As of Black Friday, the day after Thanksgiving and which marks the start of the holiday shopping season, analysts had forecast a 2.5 percent rise in November sales at stores open one year, according to Thomson Reuters data. But estimates have shrunk since the weekend, and as of Wednesday, analysts expected an increase of only 2.1 percent.

That would still be the best showing since April 2008 and marks a shift in gears from a drop of 7.8 percent in 2008, the worst drop since Thomson Reuters began tracking data in 2000.

U.S. Treasury Secretary Timothy Geithner said on Thursday the economy was slowly healing but he told CNBC television that given there were still problems in the housing market and that credit remained tight, economic problems were far from over.

Federal Reserve Chairman Ben Bernanke, making a case for a second term, told senators on Thursday at a hearing on his nomination that the U.S. central bank's forceful actions had prevented a devastating financial crisis from being even worse.

He added that the economy needs to grow by 2.5 percent annually to keep the unemployment rate stable and that the current high unemployment rate will leave long-term scars in the labor market.

Under his tenure, the Fed has slashed interest rates close to zero and pumped more than $1 trillion into the financial system to beat back the worst crisis since the Great Depression of the 1930s.

(Additional reporting by Lucia Mutikani, Glenn Somerville and Mark Felsenthal in Washington; Editing by James Dalgleish)

Unemployment Ben Bernanke Fall