(Reuters) - Employment growth accelerated last month and the jobless rate dropped to a near three-year low of 8.5 percent, the strongest evidence yet the economic recovery is gaining steam.

Nonfarm payrolls increased 200,000 in December, the Labor Department said on Friday. It was the biggest rise in three months and beat economists' expectations for a 150,000 gain.

The unemployment rate dropped from a revised 8.7 percent in November to its lowest level since February 2009, a heartening sign for President Barack Obama whose re-election hopes could hinge on the state of the labor market.

The labor market is healing, but we still have a long way to go to recoup the losses we have endured. We may be close to a tipping point where gains can become more self-feeding, said Diane Swonk, chief economist at Mesirow Financial in Chicago.

A string of better-than-expected U.S. economic data in recent weeks has highlighted a contrast between the recovery in the world's biggest economy and Europe where the economy is widely believed to be contracting.

The stronger-than-expected jobs data was overshadowed in financial markets by concerns over Europe's debt crisis, sending U.S. stocks marginally lower. U.S. government debt prices rose and a broad index of the dollar's value hit a one-year high.

Republican presidential hopefuls have blasted Obama's economic policies as doing more harm than good.

The latest economic signs, however, could offer him some political protection. Over the course of 2011, the economy added 1.6 million jobs, the most in five years.

The jobless rate, which peaked at 10 percent in October 2009, has dropped 0.6 percentage point in the last four months.

Obama welcomed the employment report and urged Congress to extend a two-month payroll tax cut through 2012 to help sustain the recovery.

We're moving in the right direction. When Congress returns they should extend the middle-class tax cut for all of this year, to make sure we keep this recovery going, he said.

Employment remains about 6.1 million below its pre-recession level and at December's pace of job growth, it would take about 2-1/2 years to win those jobs back.

Unseasonably mild weather last month accounted for some of the boost to payrolls, contributing to hefty gains in construction employment. Courier jobs also rose sharply, a gain the Labor Department pinned on strong online holiday shopping.

Those jobs could be lost in January and the unemployment rate might rise as Americans who have abandoned the hunt for work are encouraged back into the labor market.

FASTER JOB GROWTH PACE STILL NEEDED

The household survey, from which the unemployment rate is derived, showed most of the drop in the jobless rate was due to gains in employment as the labor force shrank only modestly.

While economists generally regard the payrolls figures from the government's survey of employers as the most-reliable gauge of hiring, employment as measured by the household survey has now shown five straight months of solid gains.

A broad measure of unemployment, which includes people who want to work but have stopped looking and those working only part time but who want more work, also dropped to an almost three-year low of 15.2 percent from 15.6 percent in November.

All told, 23.7 million Americans are either out of work or underemployed.

With the labor market still far from healthy, the debt crisis in Europe unresolved and tensions over Iran threatening to drive up oil prices, the U.S. economy faces stiff headwinds.

Economists predict the recovery will lose a step early this year after expanding in the fourth quarter at what is expected to be the fastest pace in 1-1/2 years.

This should keep alive the possibility of the Federal Reserve embarking on a third round of asset purchases to spur stronger growth, even though prospects of a further easing of monetary policy were damped a bit by the jobs data.

The Fed will be watching for further credible evidence that this improving trend is gaining traction because we also went through a better period in the first quarter of last year, said Anthony Karydakis, chief economist at Commerzbank in New York.

New York Federal Reserve Bank President William Dudley on Friday suggested the U.S. central bank was still leaning toward further policy easing, describing the recovery as frustratingly slow and the unemployment rate as unacceptably high.

GOVERNMENT A DRAG

All the job gains in December came from the private sector, where payrolls rose 212,000 - the most in three months. Government employment contracted 12,000, with most of the drag coming from the local government segment.

The pace of government job losses is moderating. Some states have been reporting an increase in revenues and states even hired more teachers last month.

For all of 2011, the private sector added 1.9 million jobs, while government employment fell 280,000. A measure of the share of industries that showed job gains during the month rebounded in December after falling sharply in November.

Construction payrolls increased 17,000 after falling 12,000 in November. Mild weather has boosted groundbreaking for new homes. Transportation and warehousing employment jumped 50,200.

The bulk of the rise came from the messenger industry, which added 42,000 jobs, reflecting an increase in deliveries of online purchases made during the holiday season.

Manufacturing jobs rose 23,000, the largest increase since July. Factory employment rose 225,000 last year, sustaining gains for the first time since 1997.

Retail employment rose 27,900, slowing after hefty gains in November as retailers geared up for a busy holiday shopping season. But temporary hiring - seen as a harbinger of future hiring - fell 7,500 in December after gaining 11,200.

Even though employment picked up last month, hourly earnings rose a modest four cents, indicating that most of the jobs being created are low paying.

This is a potentially troubling sign for consumer spending, which has been largely supported by a reduction in savings.

Firms need to grow wages faster if consumption is to accelerate. There is not a lot of appetite to give raises, said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

(Additional reporting by Alister Bull; Editing by Andrea Ricci)