WASHINGTON - U.S. manufacturing activity hit its highest level in 3-1/2 years last month and pending home sales contracts unexpectedly surged in September, allaying fears the economy's budding recovery would falter.

The factory gauge from the Institute for Supply Management on Monday pointed to a brisk growth pace in the fourth quarter and hinted at an improvement in the labor market in October.

These numbers are going to get people more confident in the recovery. ... They tend to argue for forward momentum going into the end of the year, said Nick Kalivas, vice president of research at MF Global in Chicago.

ISM's index of national factory activity rose to 55.7 in October, the highest level since April 2006, from 52.6 in September. Analysts had expected a reading of just 53.0.

It was the third straight month the gauge came in above 50, the dividing line between expansion and contraction.

Norbert Ore, chairman of the ISM manufacturing business survey committee, said the findings suggest the economy could grow at an annual 4.5 rate in the fourth quarter, up from the 3.5 percent pace in the third quarter.

In a separate report, the National Association of Realtors said its Pending Home Sales Index, based on sales contracts signed, rose 6.1 percent to 110.1 in September -- the highest level since December 2006 -- as first-time buyers rushed to take advantage of a soon-to-expire tax credit.

Pending home sales have now risen for eight straight months, the longest streak since on records dating to 2001, and stand a record 21.2 percent above their year-ago level.

A separate report from the Commerce Department that showed spending on construction projects rose 0.8 percent in September buttressed the view that the property sector was stabilizing.

U.S. stocks initially rallied sharply on the data, but later trimmed their gains and were close to flat in mid-afternoon. .N

Investor sentiment on Monday was also bolstered by surveys showing that manufacturing activity in the euro zone expanded for the first time in 17 months and picked up in Britain and China, indicating a global economic recovery is underway.


President Barack Obama said measures taken by his administration -- including a $787 billion stimulus package -- had pulled the economy back from the brink, but cautioned there was still a long way to go to achieve full recovery.

We just are not where we need to be yet. We've got a long way to go. We are still seeing production levels that are significantly below peak levels. And most distressing is the fact that job growth continues to lag, said Obama at a meeting with his economic recovery advisory board.

U.S. Federal Reserve officials meet on Tuesday and Wednesday and are expected to signal a willingness to keep their stimulative policies in place for some time yet to make sure a self-sustaining recovery takes root.