The number of U.S. workers filing new applications for jobless benefits unexpectedly fell last week to the lowest level in about 17 months, suggesting the economy might be on the cusp of creating jobs.

While some analysts cautioned that a holiday-shortened week may have kept some unemployed workers from filing for benefits, others said the data showed the battered U.S. labor market was healing.

Initial claims for state unemployment benefits dropped to a seasonally adjusted 432,000 in the week ended December 26 from 454,000 in the prior week, the Labor Department said on Thursday. The prior week figure was revised from the government's initial report of 452,000.

Claims fell to their lowest level since the week of July 19, 2008, and were below economists' expectations for a rise to 460,000.

It's consistent with a slow, steady improvement in the labor market, said Robert MacIntosh, chief economist at Eaton Vance Corp in Boston. We're not out of the woods, but this is what you want to see.

The data helped lift U.S. stocks as the market opened, though major indexes soon slipped into negative territory in light pre-holiday trade. An industry association's downward revision of readings on business activity in the U.S. Midwest a day after it reported vigorous growth weighed on the market.

The Institute for Supply Management-Chicago revised its business barometer index, which gives a picture of how manufacturers are faring, to 58.7 for December from the 60.0 it reported on Wednesday. A subindex on employment, which the group originally said had showed growth, was revised to 47.6 from 51.2.

Any reading above 50 indicates expansion. The revised figures reflected adjustments for seasonal fluctuations.

But the jobless claims figures helped send U.S. government bond prices lower and the dollar higher, rising against the yen and cutting losses against the euro, as traders priced in greater chances of Federal Reserve interest rate hikes next year.

The year has just ended on a high note for initial claims with a more promising outlook in 2010, said Ian Pollick, an economic strategist at TD Securities in Toronto.

The data on unemployment insurance claims was the latest to show the labor market moving toward health after two years of heavy job losses as the economy pulls out of a deep recession.

Many economists think the U.S. economy, which returned to growth in the third quarter, expanded at a 4 percent annual rate or better in the final three months of the year.

Some think December will be the first month in two years that more jobs were created than lost, a case buttressed by the claims data.

I think it gives you a better chance of having a positive (employment) number, said MacIntosh, of Eaton Vance. The probability of a positive number is still low, but it's a little bit higher.

The government's closely watched payrolls report on December employment is due at the end of next week.

A Labor Department official said based on seasonal factors, there would normally be a rise in the number of initial claims this time of year. Instead, the unadjusted data showed a decline of about 8,000 applications.

The four-week moving average, which irons out weekly fluctuations, fell by 5,500 to 460,250, marking the 17th straight weekly decline.

The drop took the closely watched average to its lowest mark since the week of September 20, 2008, around the time when the collapse of Lehman Brothers sparked a global financial market panic and intensified the recession.

The number of people still claiming benefits after an initial week of aid fell to 4.98 million in the week ended December 19, the latest week for which data is available, from 5.04 million in the prior week. It was the first time so-called continued claims had dropped below 5 million since February. However, the ranks of long-term unemployed on extended benefits rolls rose.

Fed officials have cited the high level of unemployment as a reason to keep benchmark overnight interest rates near zero for an extended period.

While job losses have braked sharply in recent months, the unemployment rate in November stood at 10 percent, just off the 26-1/2 year high hit in October.

(Additional reporting by Tim Ahmann in Washington and Burton Frierson in New York; Editing by Neil Stempleman, Dan Grebler and Leslie Adler)