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UPDATE 1-U.S. manufacturing grows in Sept for 1st time since May

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NEW YORK, Oct 1 (Reuters) - The U.S. manufacturing sector expanded in September for the first time since May as new orders and employment picked up, an industry report showed on Monday.

The Institute for Supply Management said its index of national factory activity rose to 51.5 from 49.6 in August, topping expectations in a Reuters poll for 49.7.

It was the first time since May that the index has been above the 50 threshold that indicates expansion in the sector.

The forward-looking new orders gauge also rose to its highest level since May at 52.3 from 47.1, while employment gained to 54.7 from 51.6.

"We're not quite at the point where things are good, but this indicates strongly that things are not so bad," said Adam Sarhan, chief executive of Sarhan Capital in New York.

U.S. stocks extended their advance immediately after the data, while Treasuries erased gains and the euro hit a session high against the dollar.

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Still, the rate of growth was modest and some components remained in contraction territory. Exports continued to shrink, though the rate of contraction was not as severe with the index rising to 48.5 from 47.

Similarly, production rose to 49.5 from 47.2.

After helping support the U.S. economic recovery, manufacturing has faltered in recent months, stung by weaker growth in China and the on-going uncertainty surrounding the euro zone debt crisis.

A different manufacturing survey from Markit showed the sector closed out its worst quarter in three years as foreign demand for U.S. goods fell sharply.

The U.S. economy grew at a 1.3 percent rate in the second quarter and most analysts expect growth will remain sluggish, though the economy should escape another contraction.

In a positive sign for the economy, separate data showed lending to small businesses rose in August for a second straight month.

(Reporting by Leah Schnurr; Editing by Chizu Nomiyama)

((leah.schnurr@thomsonreuters.com)(+1 646-223-6026)(Reuters Messaging: leah.schnurr.thomsonreuters.com@reuters.net))

Keywords: USA ECONOMY/MANUFACTURING