But the pace of growth will probably not accelerate much. Analysts said the drop in claims could have been exaggerated by seasonal factors and noted not all the details of the factory report were bright.

In addition other data on Thursday showing a drop in new home building in December after hefty gains the prior month.

Still, the employment and factory data added to a rash of stronger-than-expected economic signals in the United States, even as Europe's debt crisis is expected to push the region into a mild recession this year.

"The domestic economy in contrast continues to show signs of finding a footing," said Steven Ricchiuto, chief economist at Mizuho Securities in New York.

The recovery gained steam in the last three months of 2011.

Initial claims for state unemployment benefits plunged 50,000 to a seasonally adjusted 352,000, the lowest level since April 2008, the Labor Department said.

That was the largest drop since September 2005 and took claims within spitting distance of the 350,000 mark that economists say would signal strong job growth.

The claims data covered the survey period for January nonfarm payrolls and claims dropped by 14,000 between the December and January survey periods.

But claims tend to be volatile around this time of year. The four-week moving average of claims, considered to be a better measure of labor market trends, fell 3,500 to 379,000 last week. It has held below 400,000 for 10 straight weeks.

"The initial indications for the jobs report in January are encouraging and suggest that we will see another 200,000 plus reading on private payrolls for the month," said John Ryding, chief economist at RDQ Economics in New York.

Payrolls increased 200,000 in December, with the unemployment rate dropping to a near three-year low of 8.5 percent.

Separately, the Philadelphia Federal Reserve Bank's business activity index rose to 7.3 from 6.8 in December. A reading above zero indicates expansion in the Mid-Atlantic region's manufacturing.

However, new orders and shipments slowed. Unfilled orders and delivery time fell, indicating factory activity in the region could slow in the months ahead.

Stocks on Wall Street advanced on the data and the Standard & Poor's 500 index was on course for a third straight day of gains. Prices for U.S. Treasury debt fell and the dollar was weaker against a basket of currencies.

HOUSING MIXED

Other data showed housing starts fell 4.1 percent to a seasonally adjusted annual rate of 657,000 units in December. All the drag came from the volatile multi-family segment, which plunged 20.4 percent.

Single family starts - which account for a larger share of new home construction - rose 4.4 percent, adding to views that the housing market decline has bottomed and home construction will contribute to economic growth this year.

The continued stream of relatively better economic data could further temper expectations among some economists that the Federal Reserve could launch a fresh round of bond buying to spur the recovery.

The Fed meets next week and no policy action is expected, outside from the possibility the central bank may signal it will keep overnight rates pressed to zero for longer than had previously been expected.

But with inflation showing little signs of life, the U.S. central bank will stay very much in the picture.

INFLATION STILL MUTED

The Consumer Price Index was unchanged in December for a second straight month. Core CPI - excluding food and energy - inched up 0.1 percent after rising up 0.2 percent in November.

"If inflation continues to moderate, it definitely opens the door for additional quantitative easing by the Fed," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester Pennsylvania.

Last month, overall inflation was held back by gasoline prices, which fell 2.0 percent - declining for a third straight month. Food prices rose a modest 0.2 percent after nudging up 0.1 percent in November.

Overall consumer prices rose 3.0 percent year-on-year after increasing 3.4 percent in November.

Core consumer prices were last month dampened by new motor vehicle costs, which fell 0.2 percent - the third straight month of declines. Prices for used cars and trucks dropped 0.9 percent, falling a fourth month in a row.

Apparel prices slipped 0.1 percent, indicating discounting by retailers to attract holiday shoppers. Apparel prices rose 0.6 percent in November.

But housing costs held up, with owners' equivalent rent rising 0.2 percent last month, reflecting the rising demand for rental apartments as the weak housing market pushes Americans away from home ownership. This category rose 0.1 percent in November.

In the 12 months to December, core CPI increased 2.2 percent after rising by the same margin in November. This measure has rebounded from a record low of 0.6 percent in October.

The Fed would like to see core inflation at 2 percent or a little under, although the price measure its follows most closely tends to run below the core CPI.

(Additional reporting by Jason Lange; Editing by Andrea Ricci)

• A Permanent Economic Emergency