The U.S. manufacturing sector grew at its fastest pace in nearly seven years in January and signs of inflation jumped more than expected as the world's biggest economy gained traction.

The Institute for Supply Management's manufacturing survey -- which came as U.S. corporations announced strong profits and sales -- also showed employers were thinking about ramping up hiring, one of the weak spots of the recovery so far.

Friday's closely watched U.S. payrolls report is expected to show the economy added jobs for a fourth straight month but still not at the rate needed to make a big reduction in unemployment,

The ISM manufacturing index climbed to 60.8 in January, the highest reading since May 2004 and well above analysts' expectations. A reading above 50 indicates expansion.

All in all, the ISM report showed the trend in manufacturing output growth (and hiring) rising solidly at the beginning of 2011, economists at UBS Investment Research said in a note to clients, adding the economy was gaining speed.

The new orders component, an indicator of future growth, jumped to 67.8 from 62.0.

The index's employment component reached its highest level since April 1973, although that will not necessarily equate to higher levels of hiring in the near term.

I still would caution that the employment number is more about the willingness to hire, rather than an increase in the absolute numbers, said Norbert Ore, chair of the ISM manufacturing business survey committee in Atlanta, Georgia.

At the end of the day it doesn't equate to a large number of jobs, he said.

The Federal Reserve has said its $600 bond-buying billion program is still needed for an economy far from full health, especially with an unemployment rate above 9 percent.

The prices-paid component of the ISM index jumped to 81.5 from 72.5 in December and coincided with signs of rising inflation around the globe as firms ramp up production.

But economists said the Federal Reserve would not be overly worried by the jump.

While the prices paid index suggests higher input costs, the overall impact on consumer price inflation monitored by the Federal Reserve will remain muted as wage growth, a key driver of service costs, has remained moderate, said John Silvia, chief economist at Wells Fargo Securities.

Inflation-sensitive U.S. Treasury debt prices added to losses after the report. The S&P 500 stock index climbed more than 1 percent to its highest level in more than two years.

Underscoring the uneven nature of the recovery, a separate report from the U.S. Commerce Department showed construction spending fell in December to its lowest level in more than 10 years as the housing market continues to struggle.

Construction spending dropped 2.5 percent to an annual rate of $787.9 billion, its lowest since July 2000.

The U.S. manufacturing sector has expanded for the last 18 months, helping a broad recovery in corporate profits.

More than 70 percent of S&P 500 companies that have reported earnings for the last quarter have exceeded Wall Street's expectations.

United Parcel Service Inc, seen as a barometer of the economy, on Tuesday beat estimates and forecast record profits for 2011.

There are signs that the recovery is spreading into the small business sector. Borrowing by small companies jumped for a fifth straight month in December, according to the Thomson Reuters/PayNet Small Business Lending Index.

Carmakers made a strong start to 2011. General Motors said January light vehicle sales rose 22 percent from a year ago and Ford Motor Co said sales rose 13 percent in a sign of stirring consumer appetite for bigger purchases.

The most recent gross domestic product growth figures showed the U.S. economy gathered speed in the fourth quarter to regain its pre-recession output peak with a big gain in consumer spending and strong exports.

The economy grew at a 3.2 percent annual rate in the final three months of 2010 after expanding at a 2.6 percent pace in the third quarter, the Commerce Department said on Friday.

(Additional reporting by Ellen Freilich; Editing by Padraic Cassidy)