The number of Americans filing new claims for jobless benefits dropped to a 3-1/2-year low last week, suggesting a weak U.S. economy is gradually improving even though factory data proved more mixed.

Initial claims for state unemployment benefits dropped 19,000 to a seasonally adjusted 366,000, the Labor Department said on Thursday. That was the lowest level since May 2008, and confounded economist' expectations for a rise to 390,000.

In a separate reports, two regional Fed business surveys showed stronger than expected growth in December.

The New York Federal Reserve Bank said its Empire State general business conditions index rose to 9.53 - the highest since May - from 0.61 in December. The index was boosted by a strong rebound in new orders and an improvement in hiring.

The Philadelphia Fed said its index of business conditions rose to 10.3 in December from 3.6 the previous month on a surge in new orders.

However, a report from the Federal Reserve on U.S. industrial production offered some reason for pause. Output dropped 0.2 percent in November, the first drop since April and much weaker than forecasts for a 0.2 percent gain.

The data is in line with a modestly improving overall economy here in the United Sates, said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey.

Economists cautioned that troubles in Europe remain a major risk to U.S. growth, with fresh signs emerging on Thursday that the crisis in dampening production in Asia.

Some domestic risks are also lurking as lawmakers continue to haggle over extending a payroll tax cut and emergency jobless claims for U.S. workers. Failure to reach a compromise could dent the expansion early next year.

The unexpected drop in claims last week pushed them closer to the 350,000 mark that analysts say would signal a more sustained improvement in the job market.

It offered further proof of increased momentum in the pace of economic activity, even though retail sales rose modestly in November. This is in sharp contrast to Europe, where the festering debt crisis has already pushed some economies into recession.

The Federal Reserve on Tuesday acknowledged the improvement in the jobs market, but said unemployment remained high. The jobless rate dropped to a 2-1/2 year low of 8.6 percent in November.

The U.S. central bank said the debt crisis gripping Europe was a big risk to the U.S. economy, which it described as expanding moderately.

A second report from the Labor Department showed producer prices rose slightly more than expected in November, while the year-on-year rate for prices excluding food and energy increased by the most in nearly 2-1/2 years.

The Labor Department said its seasonally adjusted index for prices received by farms, factories and refineries increased 0.3 percent, unwinding October's 0.3 percent fall.

Economists polled by Reuters had expected wholesale prices to increase 0.2 percent.

Excluding volatile food and energy, producer prices edged up 0.1 percent last month after being flat in October. That was below economists' expectations for a 0.3 percent gain.

But in the 12 months to November, core producer prices rose 2.9 percent, the largest increase since June 2009, after increasing 2.8 percent the prior month.

The report showed broad gains in producer prices but labor market slack could make it difficult for companies to pass on the increased costs to consumers.

The improving labor market tone was also highlighted by a drop in the four-week moving average of claims to the lowest since mid-July 2008.

The number of people still receiving benefits under regular state programs after an initial week of aid edged up 4,000 to 3.6 million in the week ended December 3.

Economists had forecast so-called continuing claims rising to 3.63 million from a previously reported 3.58 million.

In a further hint of economic strength, the U.S. current account deficit narrowed to $110.3 billion during the third quarter, its lowest level in nearly two years, as exports hit another record high, a government report showed on Thursday.

(Editing by Neil Stempleman)

Unemployment