U.S. factory activity shrank in March, though at a slower pace than the previous month, suggesting the sector remains a drag on the economy, according to an industry report released on Wednesday.

The Institute for Supply Management said its index of national factory activity rose to 36.3 in March from 35.8 in February, slightly above economists' median forecast for a reading of 36.0.

A reading below 50 indicates contraction in the sector, and ISM said the index has been below this level for 14 straight months.

For the first quarter, the ISM manufacturing index averaged 35.9, which corresponds to a 1.6 percent fall in real gross domestic product, according to the business group.

Over an extended period, a reading above 41.2 suggests an expansion in the overall economy, it said.

Most of the index's component readings in the latest ISM survey of manufacturers showed improvements, with the biggest seen in new orders, considered a gauge of future activity.

The March ISM manufacturing report was mildly encouraging because new orders look relatively strong, said Pierre Ellis, senior economist with Decision Economics in New York.

The new orders sub-index rose to 41.2 last month, the highest since August 2008, from 33.1 in February.

Separately, approximately a third of ISM members said the massive federal stimulus package will benefit their industries and own companies in a special question posed in March's survey.

(Reporting by Richard Leong and Ellen Freilich; Editing by James Dalgleish)