The slowdown in the U.S. economy persisted early in the third quarter with factory activity in the U.S. Mid-Atlantic region contracting in July for a third straight month and new claims for jobless aid surging last week.

Other reports on Thursday showed home resales slumped to their lowest level in eight months in June and a gauge of future economic activity slipped last month, more evidence the economy has slowed significantly in recent months.

"The data confirm that the economy has cooled off pretty considerably late in the second quarter and early in the third quarter from the pace we saw earlier in the year," said Omair Sharif, an economist at RBS in Stamford, Connecticut.

Editor's Note: The ‘Unthinkable’ Could Happen — Wall Street Journal. Prepare for Meltdown

The economy has been hit by fears of deep government spending cuts and higher taxes next year, and troubles from the debt crisis in Europe, culminating in slower job growth, weak consumer spending and soft manufacturing output.

The Philadelphia Federal Reserve Bank said its business activity index was a minus 12.9 in July compared to a minus 16.6 last month. A reading below zero indicates contraction in output in factories in eastern Pennsylvania, southern New Jersey and Delaware,

New orders dropped for a third consecutive month and a gauge of employment declined sharply to a near three-year low.

Growth in U.S. factory output slowed to a 1.4 percent annual rate in the second quarter after a brisk 9.8 percent pace in the first three months of the year, and the regional factory index suggested it continues to lose momentum.

Joel Naroff, chief economist at Naroff Economic Advisors in Holland Pennsylvania, said the biggest factor weighing on the recovery was fear that politicians in Washington would be unable to avoid the so-called fiscal cliff at the turn of the year.

"While there are real issues out there, such as Europe, what seems to be overarching factor driving business decisions is the fear of a fiscal fiasco," he said.

"Gridlock is no longer just a political game. It is having real economic effects. Until business leaders can plan with more certainty, there is little chance the economy can accelerate to a solid pace."

U.S. financial markets were little moved by the data. Stocks rose on an upbeat outlook from IBM and stronger-than-expected earnings from e-commerce company eBay. Prices for U.S. government bonds were slightly up, while the dollar dipped against a basket of currencies.

TEPID JOB GROWTH

The Labor Department said initial claims for state unemployment benefits rebounded 34,000 to a seasonally adjusted 386,000. A seasonal quirk caused claims to drop 24,000 in the prior week.

A four-week moving average, which provides a better measure of underlying trends, fell 1,500 to 375,500 - staying in the middle of the range it has held for much of 2012.

While volatility surrounding the timing of annual auto plant shutdowns for retooling makes it hard it get a reliable reading of the labor market from the claims data, economists said the report did not change views of tepid job growth.

"It looks like the labor market is in a similar state to what we saw before this volatility in the claims data began, but we won't have a clean signal for another few weeks," said Daniel Silver, an economist at JPMorgan in New York.

Last week's claims data covered the period for the government's employment count for July. The labor market has suffered three months of sub-100,000 job growth as employers put the brakes on hiring.

Fed Chairman Ben Bernanke told lawmakers this week that the U.S. central bank was watching the labor market closely and would take additional action to spur the recovery if needed.

There was also disappointing news from the housing sector, which has been the bright spot in the economy.

Home resales dropped 5.4 percent to an annual rate of 4.37 million units last month, the National Association of Realtors said. However, the median sales price hit its highest level since September 2008.

With the economy showing little vigor, economists said the chances of the Fed launching a third round of bond purchases were on the rise.

"While we believe that economic conditions have not deteriorated sufficiently to push the Federal Reserve over the edge, the odds of further policy action being taken in the near-term have clearly risen," said Millan Mulraine, senior macro strategist at TD Securities in New York.

A Reuters survey published on Thursday put the chances of further bond purchases at 50 percent, up from 45 percent in June.

Editor's Note: The ‘Unthinkable’ Could Happen — Wall Street Journal. Prepare for Meltdown