By Lucia Mutikani
WASHINGTON (Reuters) - A gauge of U.S. factory activity hit a 2-1/2-year high in November and construction spending increased solidly in October, brightening the economic outlook as the year winds down.
Monday's reports were the latest indication the economy was gaining strength despite the fiscal headwinds and could bring the Federal Reserve a step closer to scaling back its massive monetary stimulus.
"The economy is moving forward at a moderate to strong pace," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York. "This is additional evidence that the economic outlook is positive enough and expected to continue long enough and that the Fed might actually taper in December."
The Institute for Supply Management (ISM) said its index of national factory activity rose to 57.3 last month, the highest reading since April 2011, from 56.4 in October. A reading above 50 indicates expansion in the factory sector.
Last month's reading outstripped forecasts for 55.0 and was the sixth consecutive month of growth in the goods-producing sector since a contraction in May.
The ISM report mirrored a separate index released by financial data firm Markit, which showed manufacturing rebounding to a 10-month high in November.
The signs of strength in the two surveys are at odds with so-called hard data such as durable goods orders, industrial production and factory payrolls which have all pointed to some slowing in manufacturing activity.
While these sentiment surveys might be overstating the pace of economic growth, they suggested an uptick in business spending and industrial production in the fourth quarter.
"The persistent strength in the ISM increases our confidence that business investment in the fourth quarter will bounce back from the contraction in the third quarter, but we remain of the view that this rebound will be limited," said Bricklin Dwyer, a U.S. economist at BNP Paribas in New York.
Business spending on equipment fell in the third-quarter for the first time in a year.
A separate report from the Commerce Department showed construction spending increased 0.8 percent to an annual rate of $908.4 billion, the highest level since May 2009, after falling 0.3 percent in September.
The reports added to data such as retail sales and nonfarm payrolls that have offered an upbeat reading of the economy despite October's 16-day government shutdown and an anticipated drawdown on inventories, both expected to undercut growth this quarter.
U.S. stocks were little moved by the data as traders awaited Friday's employment report for November. U.S. government bond prices were trading lower, while the dollar was marginally higher against a basket of currencies.
Fed policymakers next meet on December 17-18 and minutes from their last meeting showed officials are preparing to reduce the pace of bond-buying in coming months as long as the economy continues to improve.
The increase in construction spending in October was double economists' expectations for a 0.4 percent gain and driven by a 3.9 percent jump in public construction projects. That was the largest increase since March 2004.
State and local government outlays posted the biggest advance since February 2009, adding to evidence of improving budgets after years of belt-tightening. The increase in spending on federal government projects was the largest in nearly three years.
The sturdy gains in public construction spending suggest overall government spending will likely increase again in the fourth quarter. Government spending ended three straight quarters of declines in the July-September period.
"State and local construction spending has now crossed solidly into positive territory in year-on-year terms, consistent with the improvement in state and local revenue trends," said Carl Riccadonna, senior U.S. economist at Deutsche Bank Securities in New York.
"The sequester is set to continue to weigh on federal spending in 2014, but this drag will be significantly diluted by increased outlays at the state and local level."
Private sector investment in residential and nonresidential structures will probably remain on a slow path after spending on private construction projects fell in October.
But an anticipated pick-up in business spending, industrial production and demand for long-lasting manufactured goods should help to mitigate some of that slowing.
The ISM survey showed the forward-looking new orders index jumped to its highest level since April 2011. A gauge of order backlogs also surged and inventories dropped. Imports fell, while export orders jumped.
"A recovering global economy appears to be helping domestic manufacturers," said Michael Feroli, an economist at JPMorgan in New York.
"The cooling in the import index may indicate that some of last quarter's inventory gain was due to stronger imports, and the inventory payback this quarter could partly pass over domestic factories and instead be felt in weaker import growth."
(Additional reporting by Ryan Vlastelica; Editing by Chizu Nomiyama and Krista Hughes)