width=340The frail U.S. economy was dealt fresh setbacks as new U.S. jobless claims scaled a nine-month high last week and Mid-Atlantic factory activity contracted in August for the first time in more than a year.

Other data on Thursday, including a lackluster gain in a gauge of future activity last month, also implied that expansion had lost momentum after a brisk first quarter, though economists cautioned against interpreting the reports as signs of an impending double-dip recession.

It is certainly disheartening news about the economy, said David Resler, chief economist at Nomura Securities International in New York.

It is not persuasive evidence that we have dipped into recession again but it's certainly suggestive of a more serious deterioration than we had factored into our forecasts.

Financial markets were rattled by the data and investors sold stocks in favor of safe-haven government debt.

Initial claims for state unemployment benefits increased 12,000 to a seasonally adjusted 500,000 last week, the highest since mid-November, the Labor Department said. It was the third straight week of gains, a trend last seen in January.

Financial markets had expected claims to slip to 476,000.

Separately, the Philadelphia Federal Reserve Bank said its business activity index dropped to minus 7.7, the lowest since July 2009, as new orders and shipments fell and the employment situation deteriorated.

The index was at 5.1 in July and August's fall confounded markets that had expected a rise to 7.0. It also raised the risk of contraction in overall national manufacturing activity, which has been leading the economy's recovery from its most painful the recession since the Great Depression.

A reading below zero indicates a shrinking in the region's manufacturing and the index was last negative in July last year when activity was recovering from 2008-2009 downturn.


Stocks on Wall Street tumbled and all three major indexes were trading down more than 1.5 percent in afternoon trade.

U.S. government debt prices rallied, with the yield on the two-year Treasury note falling to a record low. Bond yields move inversely to prices.

The dollar fell to a near 15-year low against the yen.

The latest data, including a third report showing the Conference Board's index of leading economic indicators rose 0.1 percent in July after dropping 0.3 percent in June, reinforced signs of sluggish third-quarter growth.

The economy's poor health, characterized by a 9.5 percent unemployment rates, has handed President Barack Obama a tough challenge and put at risk the Democratic Party's majorities in the U.S. House of Representatives and Senate in November's congressional elections.

Obama on Thursday cited the weak data as he implored the Senate to pass a stalled bill to help small businesses, which have been hard hit by tight access to credit.

They need help and if we want this economy to create more jobs more quickly we need to help them, Obama said.

As soft the economic data piles up, some analysts also worry the domestic slowdown that started in the second quarter risks pushing the global economy close to renewed recession.

If the (U.S.) economy is going down, there's no way the euro zone can withstand the slowdown, said Win Thin, senior currency strategist for Brown Brothers Harriman in New York.

The claims report covered the survey week for the government's closely watched August unemployment report and analysts said it implied payroll losses could exceed July's 131,000 decline.


The burdens facing the economy were further underlined by a report from the nonpartisan Congressional Budget Office, which forecast the national budget deficit would hit $1.342 trillion this year, a touch below the $1.368 trillion it forecast in March.

There were other mixed measures of economic activity from major retailers on Thursday, with Sears Holdings Corp. (SHLD.O) reporting a wider-than-expected quarterly loss as consumers curbed spending.

But office products company Staples Inc (SPLS.O) reported a higher quarterly profit, meeting expectations, and said it expects modest economic recovery during the rest of the year.

Ryan Sweet, a senior economist at Moody's Economy.com in West Chester, Pennsylvania, said the latest rise in jobless claims could pressure the Federal Reserve to put its contingency plan into motion.

The U.S. central bank, which has kept interest rates near zero, has said it stands ready to act should the economic picture deteriorate.

Even more disturbing in the claims report, the four-week average of new jobless claims, considered a better measure of underlying labor market trends, rose to its highest level since early December.

Claims for unemployment benefits have been stuck at lofty levels for much of this year. Payrolls grew in the first five months of this year, partly due to hiring for the decennial census, but have declined in both June and July.

There hasn't been any real improvement in the labor market. It seems companies are in holding pattern when it comes to hiring and that has created a stagnant job market. It's not clear what it's going to take to turn the corner, said Stephen Bronars, senior economist at Welch Consulting in Washington.

The economy grew at a 2.4 percent annual rate in the second quarter, much slower than the 3.7 percent pace in the first three months of the year but recent data implies the growth rate may be revised down.

(Additional reporting by Lisa Lambert in Washington, Leah Schnurr and Chris Reese in New York)