March 30 (Bloomberg) -- A gauge of U.S. business activity unexpectedly expanded this month at the fastest pace in almost two years, signaling the economy may be gaining momentum heading into the second quarter.

The National Association of Purchasing Management-Chicago said today its business barometer jumped to 61.7 in March, the highest since April 2005, from 47.9 the prior month. The increase is the biggest since records began in 1968. Readings greater than 50 signal expansion.

A surge in orders and gains in production point to an economy overcoming the damage from rising mortgage defaults and the slump in housing. The report contrasts with others this week that showed businesses were reluctant to invest until excess inventory is cleared out, economists said.

``The economy looks to be shaking off its inventory overhang and getting a double boost from improvements in the weather,'' said Chris Rupkey, senior financial economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York. ``If these data are to be believed, worries about manufacturing will be firmly put to rest.''

A report from the Commerce Department showed consumer spending increased a greater-than-forecast 0.6 percent in February and the Federal Reserve's preferred measure of inflation accelerated.

Pared Bets

U.S. Treasury securities erased gains following the reports as traders pared bets the central bank would cut rates this year. The yield on the benchmark 10-year note, which moves inversely to price, rose to 4.66 percent at 11:02 a.m. in New York from 4.64 percent late yesterday. Stock prices rose.

Economists had expected the Chicago index to rise to 49.4, based on the median estimate of 57 economists in a Bloomberg News survey. Forecasts ranged from 47 to 52.

The Chicago group surveys companies with U.S. and worldwide operations. Any group member, even one not located in the Midwest, can respond to the survey. For that reason, some economists watch the Chicago index for an early reading on the outlook for overall U.S. manufacturing, which represents about 12 percent of the economy.

ISM Forecast

The Institute for Supply Management's data, to be released April 2, may show its national manufacturing index fell to 51 in March from 52.3, according to the median forecast of economists surveyed by Bloomberg News. Economists may boost forecasts following today's release.

Today's Chicago purchasing managers' report showed the production index jumped to 64.9 from 51.2, and the new orders gauge surged to 72.2 from 48.7.

The index of order backlogs increased to 54 from 44.3. The inventories index fell 48.8 from 54.5, indicating stockpiles are being drawn down.

The group's employment index fell to 45 this month from 50.6 the previous month.

The measure of delivery times fell to 45.8 from 46.5. An index of prices paid for raw materials fell to 59.1 from the prior month's 63.2.

A jump in crude oil prices, which approached a six-month high yesterday, is adding to costs. The average price of oil on the New York Mercantile Exchange yesterday rose to $66.03, the highest since September.

Durable Goods

A Commerce Department report this week showed orders placed with factories for durable goods excluding transportation unexpectedly fell for a second month in February, putting at risk the Fed's forecast for a recovery in business spending. Orders for all durable goods -- those made to last several years -- rose a smaller-than-forecast 2.5 percent.

``Despite the recent weak readings, we expect business investment in equipment and software to grow at a moderate pace this year,'' Fed Chairman Ben. S. Bernanke told lawmakers this week. He stood by his forecast for ``moderate'' economic growth even though he said the ``uncertainties'' have increased.

The high level of inventories may remain a deterrent for some businesses. A report yesterday showed stockpiles rose at an annual rate of $22.4 billion in the fourth quarter, higher than the government's prior estimate, suggesting production may be slow to pick up. Business spending also fell, while the economy grew at a 2.5 percent pace last quarter.

The Chicago Fed says its district, which includes Indiana and Michigan, makes 40 percent of U.S. motor vehicles, 35 percent of its steel and almost half of the country's domestic farm equipment.

Factory Closings

Automakers including Ford Motor Co. and bigger rival General Motors Corp. are cutting jobs and closing factories as they lose U.S. market share to Asian rivals. Ford and GM, with credit already rated as junk, may risk even lower ratings if they can't curb spending or build more popular vehicles, Standard & Poor's said last week.

Homebuilders see little relief from the worst housing slump in more than a decade. Lennar Corp., the largest U.S. homebuilder by revenue, this week reported a 73 percent plunge in fiscal first quarter earnings, and said it may miss its 2007 profit goal.

``Market conditions are very difficult across the country,'' Miami-based Lennar's Chief Executive Officer Stuart Miller said on a conference call. ``It is unclear today where there is another shoe to drop.''

Some business are trying to reduce costs by moving overseas. Hanesbrands Inc., the clothing maker spun off from Sara Lee Corp. last year, said yesterday it will close a North Carolina textile factory with 610 employees and shift production to cheaper plants in the Caribbean and Central America.

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

Last Updated: March 30, 2007 11:15 EDT