* U.S. manufacturing sector contraction slows in May
* Consumer spending falls slightly in April
* Construction spending unexpectedly increases in April (Updates with closing market prices)
By Lucia Mutikani
WASHINGTON, June 1 (Reuters) - The U.S. manufacturing sector showed improvement in May, contracting at a slower rate for the fifth straight month, while consumer spending slipped only slightly in April, according to reports on Monday that offered more proof the deep recession is losing its bite.
The data drove U.S. stocks up more than 2.5 percent.
The Institute for Supply Management's closely monitored index of national factory activity rose to 42.8 last month from 40.1 in April. It was the highest reading since September; a reading under 50 indicates contraction.
Separately, the Commerce Department said consumer spending slipped 0.1 percent in April, less than market expectations, after a 0.3 percent fall in March. Spending on construction projects rose 0.8 percent in April from March, the biggest increase since August.
"The data provide a clear signal that the worst of the troubles in the economy appear to be behind us," said Joseph Brusuelas, an economist at Moody's Economy.com in Westchester, Pennsylvania.
"With the job market looking to have stabilized, all the necessary factors for a second-half recovery are beginning to fall in place."
Government bond prices sagged as the data cut safe-haven buying and briefly pushed the yield curve, the gap between two-year and 10-year Treasury notes, to match the previous record high of 275 basis points, from 254 basis points on Friday.
The sell-off was exacerbated by aggressive selling by mortgage players in response to a recent spike in home loan rates, which could hurt recovery prospects for an economy now in its 18th month in recession.
The improvement in U.S. manufacturing was mirrored by reports from the euro zone and the United Kingdom showing the pace of contraction in factory activity was losing momentum. In China, the manufacturing sector expanded for a third straight month in May.
But the hopeful economic outlook for the U.S. economy was
dimmed somewhat by the bankruptcy of General Motors Corp
U-SHAPED RECOVERY
"I would think that the bankruptcy and restructuring in the auto industry would tend to slow the rate of recovery right now," said Norbert Ore, chairman of the ISM manufacturing Business Survey Committee in Atlanta.
While the rise in the new orders index to a level indicating expansion reflects a V-shaped recovery, or a quick bounce back, Ore said the auto situation means the recovery likely will be much more gradual.
The new orders index expanded to 51.1 in May, rising above the 50 threshold that separates expansion from contraction for the first time since November 2007.
While consumer spending slipped modestly in April, personal income rose 0.5 percent, the biggest monthly increase since May last year, the Commerce Department said.
Analysts worry that consumer spending, which accounts for about 70 percent of U.S. economic activity, could slow in the second quarter after advancing at a 1.5 percent annual pace in the January-March quarter.
But with the government's record $787 billion stimulus package of spending and tax cuts starting to boost household incomes, spending is expected to pick up in the third quarter.
Disposable income surged 1.1 percent in April, bolstered by tax cuts and increased social benefit payments under the stimulus package. Excluding the stimulus package, disposable income rose 0.7 percent in April, the department said.
"We do expect spending to creep slowly higher in the second half of the year as the labor market deterioration becomes less severe," said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts.
Recent data has shown the housing market, which is at the heart of the recession, is close to hitting a bottom. The labor market is also showing some signs of stability.
The amount of after-tax income Americans socked away jumped to a record annual rate of $620.2 billion in April, with the saving rate -- the percentage of disposable income saved -- rising to 5.7 percent, the highest level since February 1995.
Households, buffeted by job losses and falling asset values, are cutting spending on nonessential items.
In another report, the Commerce Department said private construction spending jumped 1.4 percent in April from March, the biggest increase since August. (Additional reporting by Richard Leong in New York; Editing by Leslie Adler)