Initial claims for US jobless benefits last week logged the biggest drop since October 2001, the government said, but gloomy holiday tidings from retailers blunted the labour market cheer.

First-time applications for state unemployment insurance - a rough guide to the pace of layoffs - plunged by 60,000 to 378,000 in the week ended December 21 from a revised 438,000 the prior week, the Labour Department said.

The steep drop in claims initially helped send thinly traded stock markets higher, although they closed in negative territory.

In recent weeks, Wall Street has been fretting about potential war with Iraq, as well as the health of the economic recovery amid soft data and grim news about the holiday shopping season from US retailers.

There was less hopeful news from the retail arena. New data showed this year's US holiday sales fell 11 per cent from last year. Sales between Thanksgiving and Christmas totalled $113.1 billion, down from $127.3 billion last year, according to ShopperTrak RCT, which tracks retail sales.

Retailers depend on the key weeks between Thanksgiving and Christmas for a large portion of their sales and profits.

Wal-Mart Stores Inc., the world's largest retailer, cut its December sales outlook as a last-minute surge in holiday demand came too late to salvage results for the month.

Two reports offered mixed signals about the housing sector.

The Mortgage Bankers Association of America said US mortgage applications fell 7.8 per cent last week, even as mortgage finance giant Freddie Mac said that borrowing rates hit record lows.

Freddie Mac said 30-year mortgage rates fell to a record average of 5.93 per cent from 6.03 per cent.

"2002 was an amazing year for the housing sector," Freddie Mac's chief economist Frank Nothaft said, adding the 30-year rate averaged 6.5 per cent this year, the lowest annual average in more than 31 years.

Housing, which is expected to slow from this year's torrid pace but not fall apart completely, is garnering close attention from economists and financial markets because it has provided critical support for the economy through last year's recession and this year's slow-going recovery.

According to a report commissioned by the Homeownership Alliance and released last week, mortgage refinancing fueled one-fifth of of US economic growth since 2000.

The November existing home sales report, due today, is expected to show a pullback to a 5.63 million unit annual rate from a 5.77 million rate posted for October.

However, that rate remains vigorous and low interest rates should keep sales on track for a record performance over the year, economists at UBS Warburg said.

The retail sales numbers helped Treasury bond prices rally despite the promising jobless claims numbers.

The number of new claims fell more steeply than economists' forecasts for a decline to 404,000 and Labour offered no underlying extraordinary explanation for the drop.

Analysts cautioned against reading too much into one week's figures in this volatile series, especially during the Thanksgiving-to-Christmas period when factors such as holiday-shortened reporting weeks and bad weather may distort the data.

However, they did see some reason for optimism. "Since this number came in so low, it is an encouraging sign that the early December surge might have been temporary," said Patrick Fearon, economist with A.G. Edwards and Sons Inc.

Economist Anthony Chan agreed. "We're seeing encouraging news, because the trend is going in the right direction," Chan, managing director and chief economist for Banc One Investment Advisors, said.

"They (the numbers) are telling us that we are seeing some marginal improvement in the labor market ... Although they are moving in the right direction, they are still not strong enough," he added.

Chan says he still expects a slight rise in December's unemployment rate to 6.1 per cent from six per cent in November. The closely watched December employment report will be released on January 10.

On a less positive note, Labour said its four-week moving average, a more reliable gauge since it irons out week-to-week fluctuations, rose slightly to 404,500.