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Initial claims for state unemployment benefits dropped 17,000 to a seasonally adjusted 421,000, the Labor Department said on Thursday, below economists' expectations for 425,000.

"It's another report that suggests the monthly employment numbers that we got last week probably understated the position in jobs, and it's another number that suggests we're going to get some upside surprises in economic activity," said Michael Strauss, chief economist at Commonfund in Wilton, Connecticut.

The economy added a mere 39,000 jobs in November, with the unemployment rate spiking to 9.8 percent from 9.6 percent in October.

U.S. Treasury debt prices briefly pared gains on the jobless claims data, while the dollar trimmed gains versus the euro.

A Labor Department official said there was nothing unusual in the state level data, but noted that claims on a not seasonally adjusted level recorded their biggest increase this year, which was typical as claims tend to spike in the week after the Thanksgiving holiday.

He also said the jump reflected seasonal layoffs in industries such as agriculture and surface mining.

The four-week average of new jobless claims, considered a better measure of underlying labor market trends, fell 4,000 to 427,500, still the lowest since early August 2008.

A surprisingly small gain in employment last month blurred the labor market picture and the bigger-than-expected drop in new claims, and sustained drop in the four-week average, should strengthen perceptions a durable recovery is under way.

Job creation is expected to receive a boost from a compromise deal struck by the Obama administration and Republican lawmakers on Monday to maintain all Bush-era tax cuts through 2012, extend emergency unemployment benefits and cut employee payroll taxes by 2 percentage points.

The number of people still receiving benefits under regular state programs after an initial week of aid fell 191,000 to 4.09 million in the week ended November 27, the lowest since mid-November 2008, from 4.28 million the prior week.

Economists had expected so-called continuing claims to dip to 4.25 million from a previously reported 4.27 million.

The number of people on emergency unemployment benefits fell 233,032 to 3.71 million in the week ended November 20, the latest week for which data is available. A total of 8.30 million people were claiming unemployment benefits during that period under all programs.

Emergency benefits for 4 million people which were due to expire by February are now set to be extended.