U.S. manufacturing unexpectedly grew in August and fewer Americans filed new claims for jobless aid last week, defying a slump in confidence that threatened to push the economy back into recession.

The Institute for Supply Management (ISM) said on Thursday its index of national factory activity ticked down to 50.6 from 50.9 in July. The modest slowdown confounded economists' expectations for a fall to 48.5.

Any reading below 50 indicates a contraction in the nation's factory sector.

A separate report from the Labor Department showed initial claims for state unemployment benefits dropped 12,000 to 409,000, showing little sign of a pick-up in layoffs in the wake of declining business and consumer confidence.

We've gotten a few better reads from data, and my general sense is that things aren't as bad as the headlines read. Companies aren't seeing dramatic change, said Tom Porcelli, U.S. economist at RBC Capital Markets in New York.

U.S. stocks erased losses on the manufacturing data, while Treasury debt prices trimmed gains. The dollar rose against a broad basket of currencies.

However, key details of the ISM survey were soft and initial claims remained perched above the 400,000 level usually associated with a stable labor market.

That indicated the pace of economic growth would remain slow, but further reduced the odds of a second recession.

The net result is a slowdown, disappointing growth for the third quarter but not a recession, said John Silvia, chief economist at Wells Fargo in Charlotte, North Carolina.

Data ranging from consumer spending to industrial production have showed some strength in the economy after output barely grew in the first half of the year.

While the claims data has no bearing on August's nonfarm payrolls count to be released on Friday, it showed no evidence that businesses responded to the recent financial market turmoil by aggressively laying off workers.

Other reports suggested consumers also did not pull back in August. Many top U.S. retailers on Thursday reported better-than-expected sales last month, despite sagging consumer confidence and Hurricane Irene.

Nonfarm employment is expected to have increased 75,000 in August, according to a Reuters survey, dampened by a strike at Verizon Communications. Payrolls rose 117,000 in July.

About 45,000 Verizon workers went on strike during the survey period for August payrolls. Because they did not receive a paycheck that week, they would be counted as jobless in the government's payrolls count.

A Labor Department official said there were no special factors influencing last week's claims report. The Verizon strike helped to push up claims in the last two weeks.

The four-week moving average of claims, considered a better measure of labor market trends, rose 1,750 to 410,250 last week. The number of people still receiving benefits under regular state programs after an initial week of aid dropped 18,000 to 3.74 million in the week ended August 20.

A second report from the Labor Department underscored the economy's lingering weakness, with nonfarm productivity falling at a 0.7 percent annual rate in the second quarter -- the biggest decline since the fourth quarter of 2008.

That was a downward revision to the previous estimate of a 0.3 percent fall and the second straight quarterly decline.

A slowdown in productivity usually suggests that businesses have to add new workers to meet production, but against the backdrop of an economy growing at a near stall-speed, it implies businesses might have to cut costs to protect profits.

The report showed unit labor cost growth much stronger than previously estimated.

Unit labor costs grew at a more sturdy 3.3 percent rate in the second quarter rather than 2.2 percent. Some economists said this suggested that firms were starting to face some cost pressures. The rise in unit labor costs may be puzzling given a 9.1 percent unemployment rate.

In our view, the rise reflects a labor market that has less spare capacity than may be commonly perceived, in which case, rising labor costs are likely to continue, said Troy Davig, an economist at Barclays Capital in New York.

But the revised pace is still slower than the 6.2 percent rate in the first quarter, indicating wage pressures remain too well contained to stoke a broader rise in inflation.

(Reporting by Lucia Mutikani and Leah Schnurr, Editing by Andrea Ricci)

Unemployment