* Manufacturing unexpectedly expanded last month-ISM
* New orders, unemployment gauges improved
* Construction spending fell 0.6 pct in Aug
By Leah Schnurr
NEW YORK, Oct 1 (Reuters) - U.S. manufacturing unexpectedly expanded in September for the first time since May as new orders and employment picked up, but the pace of growth showed the economy was still stuck in a slow recovery.
The Institute for Supply Management said on Monday its index of national factory activity rose to 51.5 from 49.6 in August.
"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.
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.
The data boosted U.S. stocks, while the dollar fell from a three-week high and Treasuries prices slipped.
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The improvement in employment boded well ahead of the larger jobs report on Friday, which is expected to show the pace of hiring picked up slightly last month.
Still, the overall rate of growth in manufacturing was not yet off to the races 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.
While economic growth may accelerate a bit, "a major improvement is not on the cards," wrote Paul Dales, senior U.S. economist at Capital Economics.
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.
Dales said the improvement in factory activity was consistent with annualized gross domestic product growth of 1.5 percent to 2.0 percent.
To help bolster the economy, the Federal Reserve last month launched a third bond-buying program. Fed Chairman Ben Bernanke said on Monday the central bank's actions are necessary to support a flagging recovery.
WAIT AND SEE
The push-and-pull nature of the recovery was also seen in data that showed construction spending in August fell by the most in a year.
A separate manufacturing survey from Markit showed the sector closed out its worst quarter in three years as foreign demand for U.S. goods fell sharply.
After helping support the U.S. economic recovery, manufacturing has faltered in recent months, stung by weaker growth in China and the uncertainty surrounding the euro zone debt crisis.
Euro zone factories suffered their worst quarter since early 2009, suggesting the region may struggle to avoid recession. Factory activity in China also contracted, suggesting the world's No. 2 economy lost momentum for a seventh consecutive quarter.
Big manufacturers General Electric Co and United Technologies Corp last week told investors they expected their earnings to grow in 2013 despite the uncertainties domestically and abroad.
GE last week won $1.2 billion in orders for gas turbines from customers in the United States, Japan and Saudi Arabia, while Boeing Co said All Nippon Airways ordered 11 Dreamliner jets worth about $2.7 billion at current list prices.
Not all the news from top manufacturers has been so bright. Heavy equipment maker Caterpillar Inc last week lowered its long-term 2015 growth target, citing an "anemic" world economy.
The package of U.S. tax hikes and spending cuts set to come into effect at the start of next year, dubbed the "fiscal cliff", has also clouded the outlook and left some companies in wait-and-see mode.
"Why wouldn't you just wait a few months and see what happens?" said Scott Brown, chief economist at Raymond James in St. Petersburg, Florida
"It's not like everything stops because everybody's worried about the fiscal cliff, but you get some percentage of activity which is going to be a little bit more paralyzed."
(Additional reporting by Ryan Vlastelica in New York and Scott Malone in Boston; Editing by Chizu Nomiyama)
Keywords: USA ECONOMY/