The U.S. manufacturing sector grew for the first time in 19 months in August and home sales contracts hit a two-year high in July, more evidence the economy was pulling out of the worst recession in 70 years, reports on Tuesday showed.

The Institute for Supply Management said its index of national factory activity rose to 52.9 in August, expanding for the first time since January last year. A reading above 50 indicates expansion in the manufacturing sector.

August also marked the highest reading since June 2007.

In a separate report, the National Association of Realtors said its pending home sales index, based on contracts signed in July, rose 3.2 percent to 97.6, the highest since June 2007. Pending home sales contracts have now risen for a record six straight months.

Both the ISM and pending homes are valuable leading economic indicators and they portray an economy that has shaken off the last vestiges of recession, said Bernard Baumohl, chief global economist at The Economic Outlook Group in Princeton, New Jersey.

President Barack Obama, whose administration provided a $787 billion package of spending and tax cuts, said the bullish manufacturing report was another important sign that we are heading in the right direction and that the steps we have taken to bring our economy back from the brink are working.

U.S. stocks ignored the data amid doubts over the validity of a rally that has driven shares up nearly 50 percent from March. The Dow Jones industrial average <.DJI>, the broader S&P 500 index <.SPX> and the Nasdaq <.IXIC> all tumbled around 2 percent. For more see <.N>.

GLOBAL MANUFACTURING IMPROVES

There was also good news on factory activity in Europe and China. Euro zone manufacturing activity shrank less than previously thought in August, a survey showed on Tuesday.

China's official purchasing managers' index inched up to 54.0 in August, a 16-month high, from 53.3 in July.

The recovery in U.S. factory activity was partially driven by the government's cash-for-clunkers trade-in incentives that unleashed a surge in demand for new vehicles, though other components also showed strong gains in August.

That scheme saw U.S. auto sales booming in August. Ford Motor Co reported a 17 percent monthly sales gain and industry-wide monthly sales were on track for the first increase since October 2007.

Industrial output will contribute significantly to overall economic growth in the second half of the year, said Michael Feroli, an economist at JP Morgan in New York.

U.S. regional surveys have shown business picking up steam in August, though employment remained weak, consistent with fears the United States could be in for a jobless recovery.

The good news is that the recovery in the manufacturing and housing sectors appears to be gathering pace. The bad news is that it is still not creating any extra jobs, meaning that the U.S. is heading for yet another jobless recovery, said Paul Dales, U.S. economist at Capital Economics in Toronto.

Increased hiring is seen critical to getting a consumer-led recovery under way. The employment component of ISM showed some small sign of hope, rising to 46.4 in August to its highest since August 2008 from 45.6 in July.

Many analysts forecast the U.S. economy will return to growth in the third quarter, helped by the government's fiscal stimulus spending and the Federal Reserve's massive injections of liquidity into the banking system in the past year.

A slump in house prices contributed to the credit crunch and pushed the U.S. economy into a recession that started in December 2007, but recent housing data suggested home prices may have stopped falling.

Some stabilization in the three-year old housing downturn is seen as essential to any economic recovery.

A third report from the Commerce Department showed U.S. construction spending fell 0.2 percent overall in July to its slowest since February 2004, but private residential construction spending was up 2.3 percent, the largest rise since September.

(Additional reporting by Ross Colvin and Lisa Lambert; Editing by James Dalgleish)

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