Factory activity in the U.S. mid-Atlantic region hit a 4-1/2-year high in December and a gauge of future economic conditions rose last month, adding to evidence of a pick-up in the pace of the economy's recovery.

However, the number of people filing new applications for unemployment benefits last week rose unexpectedly, a sign that the labor market is recovering only gradually.

The data on Thursday came a day after the Federal Reserve gave a cautiously upbeat assessment of the economy and left benchmark overnight lending rates near zero. It renewed its pledge of very low interest rates for an extended period.

Most of the indicators today suggest that the economy is expanding at a healthy clip, said Chris Rupkey, chief financial economist at the Bank of Tokyo-Mitsubishi UFJ in New York.

The Philadelphia Federal Reserve Bank said its business activity index rose to 20.4 from 16.7 in November, easily beating market expectations for a slip to 16.0. A reading above zero indicates growth in the region's manufacturing sector.

In another report, the Conference Board said its Leading Economic Index increased 0.9 percent after a 0.3 percent gain in October. It was the eighth straight monthly rise.

Separately, initial claims for unemployment benefits climbed 7,000 to 480,000 last week, the Labor Department said, the second weekly rise. Markets expected a decline to 465,000.

The steadily brightening economic outlook and concerns over Greek debt hoisted the U.S. dollar to a 3-1/2-month high against the euro.

Sturdy dollar gains and a profit forecast from economic bellwether FedEx Corp that missed market estimates weighed on U.S. stocks. All three indexes ended down more than 1 percent. For more click on <.N>.

LABOR MARKET HEALING

Analysts were little worried about the rise in weekly jobless claims, saying it was distorted by seasonal factors.

The trend in initial jobless claims is heading lower. Our initial guess is that we'll have ... employment growth for the first time when the current month is reported in January, said Zach Pandl, an economist at Nomura Securities in New York.

The rise in claims occurred during the week that coincides with the government's monthly survey of employers for its closely watched report on payrolls.

The four-week moving average for new claims -- viewed as a better measure of underlying trends -- fell to the lowest since September 2008. It was the 15th weekly decline in a row.

At 467,500, the measure is closing in on the 450,000 level that some analysts say will signal labor market stability.

Both the weekly reading and the four-week moving average of initial claims is well below the November readings of 501,000 and 513,000, respectively. This suggests further declines in job losses, said Julia Coronado, an economist at BNP Paribas in New York.

Employers last month cut the fewest jobs in more than a year and the unemployment rate edged down to 10 percent from a 26-1/2-year high of 10.2 percent in October. Analysts said the data was a sign the labor market was starting to turn around.

This view was backed by the Philadelphia Fed survey's employment index, which touched its highest level in two years. There were, however, some areas of weakness in the survey, with orders and shipments slipping.

Still, the rise in factory activity in the mid-Atlantic states helped offset worries that national manufacturing activity was slowing after a barometer of activity in New York State unexpectedly plummeted in December.

This will mitigate concerns that the factory sector might be slowing. The bulk of the news suggests that the factory sector continues to expand and at a pretty good pace, said Tony Crescenzi, market strategist at PIMCO in Newport Beach, California.

(Additional reporting by Lisa Lambert in Washington and John Parry in New York; Editing by James Dalgleish)

Unemployment