The number of workers filing new claims for jobless aid fell last week and factory activity in March hit its highest level in more than 5-1/2 years, strengthening hopes for a self-sustaining recovery.

The data on Thursday came a day before the release of the government's closely watched employment report for March. It is expected to show nonfarm payrolls grew for only the second time since the economy fell into recession in December 2007.

Manufacturing has led the economy out of its deepest recession since the 1930s, but the labor market has lagged. Job growth is essential to maintain an expansion when the impetus from a rebuilding of inventories disappears later this year.

The data suggest that the economic recovery is reaching a self-sustaining stage, which means it's less prone to setbacks. If we wait a couple more months we are going to find that this recovery is very robust, said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.

Initial claims for state unemployment benefits slipped 6,000 to 439,000 in the week ended March 27, the Labor Department said.

The data, which mirrored market expectations, offered few clear hints on Friday's job figures because it covered a week outside the survey period for the March employment report.

The four-week moving average of new claims, considered a better measure of underlying labor market trends, fell 6,750 to 447,250, the lowest since September 2008.

Separately, the Institute for Supply Management said its index of U.S. factory activity rose to 59.6, the highest since July 2004, from 56.5 in February. Markets were expecting 57.0.

A reading above 50 indicates expansion in manufacturing.

While an employment subindex slipped slightly, analysts said the surge in production would eventually lead to hiring.

Chris Low, chief economist at FTN Financial in New York, said the data suggested the Federal Reserve would likely need to start bumping interest rates higher late in the year.

This is the kind of strength in manufacturing consistent with economic growth strong enough to create enough jobs to allow the Fed to raise rates in the fourth quarter if it continues, Low said.

U.S. benchmark rates are currently near zero and the central bank has pledged to keep them ultra-low while it monitors the strength of the recovery. Optimism in the economy was also reflected in the automotive sector, where sales rose sharply last month.

FAIRLY UPBEAT DATA

U.S. stocks rose on the fairly upbeat economic data, but trimmed gains after Research In Motion, the BlackBerry maker, posted quarterly profit and sales that lagged expectations. Government debt prices fell, while the U.S. dollar scaled a seven-month high against the yen.

Economists expect the jobs report on Friday to show payrolls increased 190,000 last month, boosted by hiring for the 2010 U.S. census and a bounce-back from February's weather-related losses, a Reuters survey found. Payrolls fell 36,000 in February.

The median projection from the 20 economists who have forecast payrolls most accurately over the past year predicts 200,000 jobs were created in March.

Treasury Secretary Timothy Geithner told NBC's Today show on Thursday that while the economy was going to start creating jobs again, the unemployment rate would remain high for some time. It has held at 9.7 percent for two months.

The unemployment rate is still terribly high, and it's going to stay unacceptably high for a long period of time, Geithner said.

The number of people still receiving benefits after an initial week of aid fell in the week ended March 20 to its lowest since December 2008. However, the number of people on extended employment benefits rose.

Employers are still laying off workers and planned job cuts at U.S. firms rose last month, outplacement consultants Challenger, Gray & Christmas Inc said. Planned layoffs for the first quarter were, however, down sharply from a year ago.

A swing in the inventory cycle as companies seek to restock warehouses, and a pick-up in global trade are boosting manufacturing both in the United States and overseas.

Manufacturing in Britain expanded at its fastest pace since 1994. China's vast industrial sector also grew in March. In Germany, factory activity grew at a rate not seen in almost 10 years, while France saw its manufacturing sector expand at its fastest pace since November 2006.

While manufacturing is thriving, continued weakness in the construction sector is holding back the U.S. economy.

Construction spending fell for a fourth straight month in February to the slowest rate in nearly 7-1/2 years as activity softened in every major sector from homebuilding to public construction projects, a Commerce Department report showed.

(Additional reporting by Glenn Somerville and Andy Sullivan in Washington and Steven C Johnson in New York; Editing by Andrew Hay and James Dalgleish)

Manufacturing Unemployment