Nov. 2 (Bloomberg) -- Manufacturing in the U.S. expanded faster than anticipated in October, easing concern the economic recovery will be cut short once government aid wanes.

The Institute for Supply Management’s factory index rose to 55.7, a three-year high and exceeding every estimate of the 70 economists surveyed by Bloomberg News, data from the Tempe, Arizona-based group showed today. Other reports indicated housing kept gaining after its worst recession since the 1930s.

“The economic outlook is brightening,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “Manufacturing is in the driving seat at this stage of the recovery. Housing has turned the corner.”

Stocks rose as the data showed the world’s largest economy may be gaining momentum after growing last quarter at the fastest pace in two years. More than $2 trillion in global stimulus and a cheaper dollar may also lift sales overseas, ensuring assembly lines keep humming into 2010 as factories rebuild depleted stockpiles.

The Standard & Poor’s 500 Index closed up 0.7 percent at 1,042.88 in New York, rebounding from its biggest weekly drop since May.

The median forecast of economists surveyed by Bloomberg projected the ISM index would climb to 53 last month from 52.6 in September. Estimates ranged from 52 to 55, and readings greater than 50 signal expansion.

More Contracts

The number of contracts to buy previously owned homes unexpectedly rose in September for an eighth straight month as Americans rushed to meet a deadline for a home-buyer tax credit, a report from the National Association of Realtors also showed today. The group’s pending home sales index rose 6.1 percent after a 6.4 percent gain in August, and were up 20 percent from the same time last year.

Figures from the Commerce Department showed spending on all construction unexpectedly rose 0.8 percent in September, the biggest gain in a year, driven by the largest increase in homebuilding since 2003.

Buyers are trying to beat a Nov. 30 deadline to close on a transaction and qualify for the administration’s $8,000 tax credit to Americans buying their first house. The Obama administration on Oct. 29 endorsed plans to extend the incentive that are being deliberated in Congress.

The improvement in the ISM’s manufacturing gauge was driven by a surge in production. The gains occurred after companies cut inventories at a record pace in the first six months of the year and stockpiles kept falling last quarter as consumer spending rebounded.

Laying the Groundwork

“The recovery remains firmly on track,” said John Herrmann, president of Herrmann Forecasting in Summit, New Jersey, whose projection for the index to rise to 55 matched the highest expectation. Manufacturing is “laying the groundwork for a very strong inventory restocking cycle.”

The economy expanded at a 3.5 percent pace from July through September after a yearlong contraction as government incentives spurred consumers to spend more on cars and homes, according to Commerce Department data released last week.

Ford, the only major U.S. automaker to avoid bankruptcy, said it posted its first operating profit since early 2008 on smaller discounts and higher sales. The government’s “cash- for-clunkers” plan helped revive demand after purchases dropped to a 27-year low in February.

Chief Executive Officer Alan Mulally said he is taking a “cautiously optimistic point of view” on 2010 and was not ready to project a profit because of uncertainties about how the global economy will recover.

‘Uncertain’ Outlook

“We want to see how things develop,” Mulally said. “The near-term growth outlook remains rather uncertain.”

The ISM’s employment measure showed the first sign of growth since July 2008, reaching the highest level since 2006.

Norbert Ore, chairman of the purchasing managers’ factory survey, downplayed the gain during a conference call after the report, calling it a “big surprise” and a bit “misleading.” The index is a gauge of sentiment rather than actual hiring, he said, and mainly reflected employment of temporary workers and some factory callbacks of previously dismissed staff.

Cummins Inc., the largest maker of heavy-duty diesel truck engines in North America, last week reported third-quarter profit that topped analysts’ estimates after the company cut jobs and slashed inventories. Chief Executive Officer Tim Solso cut about 7,500 workers, including full-time and temporary employees, from late 2008 through June, and has since recalled about 900.

‘Challenging’ Climate

“While we saw improvement in some markets in the third quarter, we expect the economic climate to remain challenging until late 2010 -- especially in the United States and Europe,” Solso said in an Oct. 30 statement.

A Labor Department report Nov. 6 is projected to show employers cut 175,000 workers from payrolls in October and unemployment climbed to a 26-year high of 9.9 percent, according to the median forecast of economists surveyed.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

Last Updated: November 2, 2009 16:39 EST