Cessna employee Lee York works on an engine on the Cessna business jet assembly line at their manufacturing plant in Wichita, Kansas, March, 2013. Reuters / Jeff Tuttle

The U.S. manufacturing sector reached its highest production level of the year in July as stable demand combined with slowly improving business conditions, according to a report released Thursday.

The Institute for Supply Management (ISM) says that business conditions improved for the second consecutive month. The group's Purchasing Managers Index (PMI) increased by 4.5 percent in July to 55.4 percent, registering higher than June's reading of 50.9 percent. That rise indicates that the manufacturing sector expanded for the fifth time in the first seven months of 2013, while the overall economy grew for the 50th consecutive month.

July's 55.4 percent level is higher than what analysts were expecting. The consensus among analysts polled by Briefing.com expected, on average, that July's ISM would be 51.5 following June's level of 50.9. A mark above 50 indicates industry expansion while below 50 indicates contraction.

The strong reading was bolstered by new orders, which increased by 6.4 percentage points to 50.3 percent, and also by the Production Index, which increased by 11.6 points to 65 percent. The employment index rose to 54.4 percent in July, 5.7 percentage points above June's 48.7 dip. However, the Prices Index registered 49 percent, down 3.5 percentage points below June's mark as overall raw materials prices dropped.

Purchasing managers are considered to have current and relevant insight into a company's view of the economy. The report, based on a survey of about 400 purchasing managers in the manufacturing industry, measures business conditions such as employment, production, new orders, prices, supplier deliveries and inventories. It is a leading indicator of economic health, as businesses react quickly to market conditions.