New U.S. claims for unemployment benefits fell more than expected last week and the four-week moving average slipped to a fresh two-year low, reviving hopes a labor market recovery was under way.

Initial claims for state unemployment benefits dropped 17,000 to a seasonally adjusted 421,000, the Labor Department said on Thursday, below economists' expectations for 425,000.

It's another report that suggests the monthly employment numbers that we got last week probably understated the position in jobs, and it's another number that suggests we're going to get some upside surprises in economic activity, said Michael Strauss, chief economist at Commonfund in Wilton, Connecticut.

The government's employment report last week showed employers added a mere 39,000 jobs in November and the jobless rate rose to 9.8 percent from 9.6 percent.

A separate report from the Commerce Department on Thursday showed wholesale inventories rose 1.9 percent in October, while sales increased at the fastest rate in seven months, adding to optimism about a healthy holiday shopping season.

Stocks on Wall Street opened higher on the jobless claims report, while prices for U.S. government debt raced to session highs. The U.S. dollar trimmed gains versus the euro.

The surprisingly small gain in employment last month had blurred the labor market picture and the bigger-than-expected drop in new claims should strengthen perceptions a durable recovery is under way.

The tepid economy and jobs markets are expected to receive a boost from a deal struck by the Obama administration and Republican lawmakers on Monday to maintain all Bush-era tax cuts through 2012, extend emergency unemployment benefits and cut employee payroll taxes by 2 percentage points.

In a sign that a gradual labor market healing was firmly entrenched, the four-week average of new jobless claims, viewed as a better measure of underlying labor market trends, fell 4,000 to 427,500, still the lowest since early August 2008.

Both initial claims and the four-week average have now held below the 450,000 level for five straight weeks. The 450,000 mark is generally considered by economists as the level consistent with job growth.

The change coincides with a modest improvement in small firms' sentiment and the end of the contraction in bank lending to commercial and industrial companies, said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York.

This is not an accident, in our view. Small firms, which employ half the work force, have been hamstrung by tight credit. If claims continue to drift down it would be reasonable to expect better payroll numbers very soon.

The number of people still receiving benefits under regular state programs after an initial week of aid fell 191,000 to 4.09 million in the week ended November 27, the lowest since mid-November 2008, from 4.28 million the prior week.

Economists had expected so-called continuing claims to dip to 4.25 million from a previously reported 4.27 million.

The number of people on emergency unemployment benefits fell 233,032 to 3.71 million in the week ended November 20, the latest week for which data is available. A total of 8.30 million people were claiming unemployment benefits during that period under all programs.

Emergency benefits for 4 million people which were due to expire by February are now set to be extended.

(Reporting by Lucia Mutikani and Glenn Somerville; Editing by Chizu Nomiyama)