* Jobless claims drop 37,000 last week, lowest in five years
* Housing starts surge 12.1 percent to four-year high
* Building permits gain 0.3 percent
* Mid-Atlantic manufacturing shrinks in January
By Lucia Mutikani
WASHINGTON, Jan 17 (Reuters) - The number of Americans filing new claims for unemployment aid hit a five-year low last week and residential construction surged in December, the latest signs that the U.S. economic recovery remains on track.
The reports on Thursday showed the economy was weathering an uncertain fiscal environment surprisingly well. Still, growth in the fourth quarter was likely subdued with only a modest pick-up expected in the first three months of this year.
"While growth has been slow, the damage done from the uncertainty surrounding the fiscal cliff was not sufficient to topple the recovery," said Millan Mulraine, a senior economist at TD Securities in New York.
The fiscal cliff refers to a wave of deep government spending cuts and tax increases, part of which was avoided after a last-minute agreement by U.S. lawmakers. A fight over raising the government's borrowing limit looms.
Initial claims for state unemployment benefits fell 37,000 to a seasonally adjusted 335,000, the lowest level since January 2008, the Labor Department said. It was the largest weekly drop since February 2010 and ended four straight weeks of increases.
While problems adjusting the data for seasonal fluctuations might have exaggerated the decline, economists said the report still suggested an improvement in sluggish labor market conditions and the economy as a whole.
"Having taken a pinch of salt, however, we would suggest that the trend in claims generally show no pickup in layoff activity around the turn of the year," said John Ryding, chief economist at RDQ Economics in New York.
A separate report from the Commerce Department showed housing starts jumped 12.1 percent last month to their highest level since June 2008. Permits for future home construction were also the highest in about 4-1/2 years.
Stocks on Wall Street ended higher on the fairly upbeat jobs and housing data, with the broad Standard & Poor's 500 index hitting a five-year high. Commodity prices also firmed, but U.S. government bond prices slumped.
The dollar rallied to a 2-1/2-year high against the yen.
HOUSING GAINING TRACTION
Though warm weather likely helped, the data was confirmation of the improving housing market tone, and home building made gains across all four regions. Groundbreaking also increased for both single-family homes and multi-family units.
Builders started 780,000 houses in 2012. While still low by historical standards, it was the third straight year of gains in home construction. Housing is no longer a drag on the economy and residential construction is expected to have contributed to growth last year for the first time since 2005.
"The housing recovery has steam. Interest rates are rock-bottom low, inventories of new and existing homes are lean, and the economy is creating jobs," said Patrick Newport, an economist at IHS Global Insight in Lexington, Massachusetts.
Newport said they expected starts to rise to 970,000 this year. The reports came on the heels of data this week showing solid retail sales and manufacturing growth in December.
But weak exports, a slow pace of inventory accumulation and the reversal of a surge in defense spending probably slowed growth to below a 2 percent annual pace in the fourth quarter.
In a reminder that the outlook for the economy remained shaky, a third report showed factory activity in the U.S. mid-Atlantic region contracted this month as new orders tumbled.
The Philadelphia Federal Reserve Bank said its business activity index fell to -5.8 from 4.6 in December. A reading below zero indicates contraction in manufacturing in eastern Pennsylvania, southern New Jersey and Delaware.
"Manufacturing has slowed but it's still growing. I'm not going to read too much into this until I see other regional surveys," said Gus Faucher, a senior economist at PNC Financial Services in Pittsburgh.
The claims data covered the survey week for the January data for the closely watched nonfarm payrolls report. The four-week moving average of new jobless claims, a better measure of labor market trends, fell 6,750 to 359,250, suggesting some improvement in labor market conditions.
Job growth has been gradual, with employers adding 155,000 new positions in December. The unemployment rate held steady at 7.8 percent last month. High jobless is likely to keep the Federal Reserve on an expansionary monetary policy path.
Atlanta Fed President Dennis Lockhart said on Thursday the Federal Reserve will very likely need to continue its large-scale asset purchases into the second half of this year.