Manufacturing contracted at a less severe pace last month, while consumer spending rebounded in January, according to reports on Monday that provided little cheer for an economy mired recession.

The Institute for Supply Management's index of national factory activity rose to 35.8 in February from 35.6 in January, a touch above economists' forecasts for a reading of 33.8.

But the manufacturing employment index fell to a record low in February, as financial markets brace for another U.S. jobs report scheduled for Friday. Analysts expect U.S. payroll employment to have dropped 648,000 in January, with the unemployment rate jumping to 7.9 percent from 7.6 percent.

The worst is yet to come. I think most people know that now and we just have to hang in there here -- there's not much else you can do, said Warren Simpson, managing director, Stephens Capital Management in Little Rock, Arkansas.

U.S. stocks fell, while U.S. government debt prices pared gains after the stronger-than-expected factory data. The dollar rose against the yen.

A separate report from the Commerce Department showed consumer spending rebounded 0.6 percent in January, the largest increase since May, after falling an unrevised 1 percent in December.

Incomes advanced 0.4 percent, also posting the biggest increase since May, after December's 0.2 percent decrease.

But the gains in January are likely to be temporary as wages and salaries continue to fall as the 14 month recession deepens.

Consumer confidence levels are hitting all-time lows and everybody understands that the consumer in the United States is currently under water and does not look to be turning around anytime soon, said Tim O'Sullivan, chief dealer at Forex.com in Bedminster, New Jersey.

The department attributed to rise in incomes to pay raises for federal civilian and military employees, as well as cost-of-living adjustments to several government transfer payments programs. It said excluding these factors, incomes increased by 0.2 percent in January.

Savings jumped to an annual rate of $545.5 billion, the highest level since monthly records began in 1959. The saving rate surged to 5 percent in January, the biggest advance since March 1995, as households uncertain about the economy prefer to conserve their cash.

It is good that people save but it is not good that everybody saves at the same time. That makes the current downturn more severe and long lasting, said Scott Brown, chief economist, Raymond James & Associates in St. Petersburg, Florida.

Data last week showed the U.S. economy shrank at a 6.2 percent annual rate in the fourth quarter, the deepest contraction since early 1982, when it was in the throes of recession that lasted 16 months.

Consumer spending, which accounts for more than two-thirds of economic activity, declined at 4.3 percent rate in the fourth quarter, the biggest drop since the second quarter of 1980.

In another report which underscored the severity of the current economic downturn, the Commerce Department said spending on construction projects dropped 3.3 percent to a seasonally adjusted annual rate of $986.2 billion, the lowest since June 2004, after tumbling 2.4 percent the prior month.

Private residential spending fell 2.9 percent in January after December's 4.4 percent drop. Compared to the same period last year, spending was down 28 percent. The level of spending, at a $291.5 billion rate, was the lowest in over 10 years.

(Additional reporting by Burton Frierson in New York; Editing by Neil Stempleman)

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