The U.S. manufacturing sector grew at its fastest pace in nearly seven years in January, and signs of inflation jumped more than expected in the latest sign the economic recovery is gaining traction.

The Institute for Supply Management's monthly manufacturing survey fits into a pattern of steadily improving data and comes ahead of Friday's closely watched U.S. payrolls report expected to show the U.S. economy added jobs for a fourth straight month.

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.

The ISM's employment index reached its highest level since April 1973, although that wont 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 prices paid component of the index jumped to 81.5 from 72.5 the prior month and coincided with signs of rising inflation around the globe as firms ramp up production.

It's a good number, said Gary Thayer, chief macroeconomic strategist at Wells Fargo Advisors in St. Louis, Missouri. Manufacturing is outperforming other parts of the economy, but we're also seeing some inflationary seeds in costs rising.

Inflation-sensitive U.S. Treasury debt prices extended losses after the data, while the S&P 500 stock index climbed more than 1 percent.

Underscoring the uneven nature of the recovery, however, 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 housing continues to struggle.

The Federal Reserve has argued that continued asset purchases are needed under its $600 billion program in order to support an economy that, while showing signs of improvement, is still far from full health.

The Commerce Department said on Tuesday U.S. construction spending dropped 2.5 percent to an annual rate of $787.9 billion, the lowest level since July 2000.

The most recent gross domestic product growth figures showed the U.S. economy gathered speed in the fourth quarter to regain its pre-recession 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)