U.S. labor market firming; factories still struggling

(Adds leading indicator, analyst comments, updates markets)

* Weekly jobless claims fall 4,000

* Four-week average of claims rises 2,500

* Mid-Atlantic (Shanghai: 600558.SS - news) factory activity improves in August

By Lucia Mutikani

WASHINGTON, Aug 18 (Reuters) - The number of Americans filing for unemployment benefits fell more than expected last week, reinforcing views of labor market strength that could encourage the Federal Reserve to raise interest rates soon.

Another report on Thursday showed a mild improvement in manufacturing activity in the mid-Atlantic region this month amid rising shipments from factories. But weak orders and shrinking employment suggested the manufacturing malaise was far from over.

Initial claims for state unemployment benefits dropped 4,000 to a seasonally adjusted 262,000 for the week ended Aug. 13, the Labor Department said. Economists had forecast initial claims slipping to 265,000 in the latest week.

Claims have now been below 300,000, a threshold associated with a strong labor market, for 76 straight weeks. That is the longest such stretch since 1973, when the labor market was much smaller. It is now viewed as either at or near full employment.

"The unemployment claims data point to continued low layoff rates and a solid pace of job growth," said John Ryding, chief economist at RDQ Economics in New York.

Labor market buoyancy, marked by robust hiring in the last two months and diminishing slack, could prompt the Fed to raise interest rates despite low inflation and sluggish economic growth in the first half of the year.

New York Fed President William Dudley, an influential policymaker at the U.S (Other OTC: UBGXF - news) . central bank, said on Tuesday it was "possible" to hike rates at the Fed's Sept. 20-21 policy meeting.

But the minutes from the July 26-27 meeting, which were released on Wednesday, showed Fed policymakers were divided on the urgency of a rate hike amid concerns about benign inflation.

The Fed raised its benchmark overnight interest rate in December for the first time in nearly a decade.

In a separate report, the Conference Board reported that a gauge of future U.S. economic activity increased in July for a second consecutive month.

The U.S. dollar was trading lower against a basket of currencies after the data, while prices for U.S. government debt edged up. U.S. stocks were trading slightly higher as oil prices rose and Wal-Mart raised its profit forecast after reporting higher-than-expected quarterly earnings.

MANUFACTURING CONSTRAINED

The four-week moving average of claims, considered a better measure of labor market trends as it irons out week-to-week volatility, rose 2,500 to 265,250 last week. The claims data covered the survey week for the August nonfarm payrolls report.

The four-week moving average of claims increased 7,750 between the July and August survey periods, suggesting another month of strong job gains. The economy created 255,000 jobs in July, adding to the 292,000 positions gained in June.

In a third report, the Philadelphia Fed said its business conditions index gained 5 points to a reading of 2.0 in August as more companies reported an increase in shipments. August marked the third positive reading for the index this year.

But details of the survey were weak, with a measure of new orders contracting after surging in July. There were continued declines in factory employment, which fell to a seven-year low. The length of the work week declined further.

Shipments, however, rose and manufacturers were also asking higher prices for their goods while appearing to pay more for raw materials. Manufacturers were more upbeat about business prospects and capital spending in the next six months.

Manufacturing remains constrained by the delayed pass-through of the U.S. dollar's rally between June 2014 and December 2015. The sector, which accounts for 12 percent of the U.S. economy, has also been undermined by an inventory bloat as well as lower oil prices, which have contributed to a sharp downturn in business spending.

There are, however, tentative signs that the energy drag on business investment could be fading. The Fed reported on Tuesday that oil and gas drilling surged in July, notching a second straight monthly gain. Oil drilling firms have increased the number of rigs in recent months.

"We had expected improvement in the manufacturing sector following the drags from the stronger dollar and inventory correction, but regional manufacturing surveys released so far have not provided much reason for optimism on the sector," said Daniel Silver, an economist at JPMorgan (LSE: JPIU.L - news) in New York.

(Reporting by Lucia Mutikani; Editing by Paul Simao)