The Institute for Supply Management (ISM) report on Thursday also showed a sustained increase in prices paid by services industries for inputs, potentially signaling that the days of very low inflation could be coming to an end.

The economy is likely to get a boost from President-elect Donald Trump's plan to increase infrastructure spending and cut taxes. That, together with a tightening labor market and firming inflation, could allow the Federal Reserve to increase interest rates in March, economists say.

"It appears that both growth and price pressures are beginning to pick up and we continue to project the next rate hike takes place at the March Fed policy meeting," said John Ryding, chief economist at RDQ Economics in New York.ISM said its non-manufacturing activity index was at 57.2 last month, matching November's reading, which was the highest since October 2015. A reading above 50 indicates expansion in the sector, which accounts for more than two-thirds of U.S. economic activity.

Services industries reported new orders jumped 4.6 percentage points last month to their highest level since August 2015.

Prices paid by non-manufacturing industries for materials and services rose 0.7 percentage point, hitting their highest level in nearly 2-1/2 years and marking the ninth consecutive monthly increase. That suggested inflation, which has persistently run below the Fed's 2 percent target, was poised to rise in the coming months.

A measure of services sector employment fell 4.4 percentage points last month. The drop, however, followed a surge in November, which had lifted the subindex to a 13-month high. ISM noted that labor, especially in the construction sector, "continue to be in short supply."

Economists do not believe that the decline in services employment last month will significantly impact December's nonfarm payrolls report, which the U.S. government is scheduled to release on Friday.

They also brushed aside another report on Thursday from payrolls processor ADP showing that private employers added 153,000 jobs in December after boosting payrolls by 215,000 in November. The ADP report, which is jointly developed with Moody's Analytics, has a poor record of predicting the private payrolls component of the government's closely watched employment report because of differences in methodology.

Nonfarm payrolls likely increased by 178,000 jobs in December after the same gain in November, according to a Reuters survey of economists.

"We don't view the data as strong evidence that payrolls will undershoot expectations on Friday," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics in New York.

But traders took a different view, selling the dollar, which declined more than 1 percent against a basket of currencies. .DXY Prices for U.S. government debt rose, while stocks on Wall Street fell.

TIGHTENING LABOR MARKET

Trump, who campaigned on a pledge to spur job growth largely by revitalizing U.S. manufacturing, will inherit a labor market that is considered to be at or near full employment, with a jobless rate at a nine-year low of 4.6 percent.

That strength was underscored by a third report from the Labor Department on Thursday showing initial claims for state unemployment benefits dropped 28,000 to a seasonally adjusted 235,000 for the week ended Dec. 31. That was close to the 233,000 touched in mid-November, which was the lowest level since November 1973.

Initial jobless claims have now been below 300,000, a threshold associated with a healthy labor market, for 96 consecutive weeks. That is the longest stretch since 1970, when the labor market was much smaller.

But with claims data for six states and one territory estimated because of the New Year's holiday, last week's drop likely exaggerates labor market strength. The four-week moving average of claims, considered a better measure of labor market trends as it irons out week-to-week volatility, fell 5,750 to 256,750 last week.

Tightening labor market conditions and gradually firming inflation allowed the Fed to raise its benchmark overnight interest rate last month by 25 basis points to a range of 0.50 percent to 0.75 percent.

While the U.S. central bank forecast three rate hikes for 2017, minutes of the Dec. 13-14 policy meeting released on Wednesday suggested the pace of increases would largely be determined by the labor market and fiscal policy.

In a fourth report on Thursday, global outplacement consultancy Challenger, Gray & Christmas said U.S.-based employers announced plans to cut 33,627 jobs from payrolls last month, up 25 percent from November. Still, that was below the monthly average of 43,910 job cuts for 2016.

Layoffs last month were led by the defense, automotive, energy, transportation and government sectors. Employers announced 526,915 layoffs last year, down 12 percent from 2015.

(Reporting by Lucia Mutikani; Additional reporting by Richard Leong in New York; Editing by Paul Simao)