New claims for unemployment benefits rose modestly last week but hovered near levels normally associated with improving labor market conditions, in a hopeful sign for the struggling economy.

Initial claims for state jobless aid climbed 6,000 to a seasonally adjusted 401,000, the Labor Department said, from 395,000 the prior week.

That left claims holding steady around the 400,000 mark, which is usually regarded as consistent with some improvement in the jobs market, for a second week. Economists, who had expected claims to rise to 410,000, saw this as yet another sign the ailing economy was not falling back into recession.

Claims suggest that layoffs remain contained despite high uncertainty in the economy. We continue to expect moderate growth rather than a recession, said Guy Berger, an economist at RBS in Stamford, Connecticut.

The data falls outside the survey period for the government's closely watched employment report for September, which will be released on Friday.

Nonfarm payrolls likely increased 60,000 last month, according to a Reuters survey, after being flat in August.

The gain in nonfarm employment will mostly reflect the return of 45,000 striking Verizon Communications workers to payrolls. The jobless rate is seen steady at 9.1 percent.

U.S. stocks rose for a third day, while prices for government debt fell. The dollar was marginally weaker against a basket of currencies.

THREAT FROM EUROPE

The lofty level of unemployment has put downward pressure on incomes, weighing on consumer spending.

However, reports by U.S. retailers on Thursday suggested back-to-school sales were brisk last month, and 23 retailers posted an average sales gain of 5.1 percent at stores open at least a year, according to Thomson Reuters. Analysts were anticipating a 4.6 percent rise.

Data ranging from manufacturing to motor vehicle sales have also suggested that the economy, which expanded at a 1.3 percent annual rate in the second quarter, could avoid an outright contraction in output.

While the weak labor market remains the Achilles heel of the recovery, an even bigger threat is looming from Europe's debt crisis. Economists warn troubles in the euro zone could push the U.S. economy into a new recession.

Treasury Secretary Timothy Geithner said on Thursday Europe's debt crisis could significantly damage the U.S. economy, although major U.S. banks and money market funds have little direct exposure.

Europe is so large and so closely integrated with the U.S. and world economies that a severe crisis in Europe could cause significant damage by undermining confidence and weakening demand, he said according to testimony obtained by Reuters.

The European Central Bank on Thursday took steps to pump more cash into the banking system in a bid to contain the debt problem.

Slow domestic growth prompted the Federal Reserve last month to announce a new measure designed to push long-term borrowing costs lower by shifting assets on its balance sheet.

Interest rates have dropped in response, with the 30-year fixed mortgage rate falling to a record low 3.94 percent this week, according to Freddie Mac.

Although the labor market stalled in August, it appears to have regained some footing in late September. The four-week moving average of initial claims -- considered a better measure of labor market trends -- fell for a second week.

If initial jobless claims continue to trend lower that would be an encouraging sign that labor market conditions may be improving, said John Ryding, chief economist at RDQ Economics in New York.

The number of people still receiving benefits under regular state programs after an initial week of aid dropped to its lowest level since July in the week ended September 24.

A total of 6.86 million Americans were claiming unemployment benefits during the week ended September 17 under all programs, down 123,009 from the prior week.

(Editing by James Dalgleish)