The ailing U.S. manufacturing sector cobbled together its best performance of 2001 in June, raising hopes the sector is clawing out of a severe 11-month slump, an industry report showed on Monday.

The National Association of Purchasing Management said its monthly manufacturing index rose to 44.7 in June -- its best reading this year -- from 42.1 in May, compared with a decade low of 41.2 hit in January.

A reading under 50 signals manufacturing activity -- nearly one-fifth of the overall economy -- is contracting, so June's improvement signals the sector stemmed its pace of declines, although it did not expand. The index has held under 50 since August 2000.

``The recession in manufacturing might finally be abating,'' said Joe Abate, senior economist at Lehman Brothers in New York. ``Nevertheless, in the aggregate, the sector remains anemic.''

The NAPM new orders index, a critical indicator of demand for factory goods in the pipeline, jumped to 48.6 from 45.5 in May. While firms have faced shrinking orders for a full year, the gain buoyed prospects business will pick up in coming months.

``If new orders are picking up you'll eventually see production and employment follow suit,'' said Michael Moran, chief economist at Daiwa Securities America.

The production index rose to 46.2 from 42.7 in May, indicating firms are slowing the pace of production cutbacks.

The NAPM employment index rose to 36.3 in June from a decade low of 35.0 in May, a sign the sector may be stemming the pace of sharp job losses.

U.S. stock markets cheered signs that industry may have weathered its worst declines.

The blue-chip Dow Jones industrial average rallied more than 1 percent in mid-morning to 10,619, shrugging off an earnings warning by Minnesota Mining & Manufacturing.

U.S. Treasuries, which suffered heavy losses in the wake of a stream of stronger-than-expected economic reports last week, shrugged off the NAPM report and bounced higher.

The report showed that firms continued to liquidate bloated stocks of goods built up in last year's boom times at a quick pace, although inventory adjustment slowed a bit in June.

Shaving inventories is necessary before factories can fire up production again. But it also implies a drag on economic growth in the second quarter.

The NAPM inventories index rose to 40.8 in June from 38.7 in May.

In a troubling sign, new export orders shrank for the third straight month, suggesting firms are continuing to feel pain from a strong dollar, which raises the cost of U.S. goods sold abroad, and from slower overseas growth.

NAPM's new export orders index slipped to 45.5, from 45.6 in May.

On a positive note, manufacturers faced lower prices for inputs for a fourth straight month as energy costs fell. The NAPM prices index fell to 42.3 in June from May's 45.2.

``For those who have a short-term fear of inflation, probably that's not a problem because we are seeing deflationary pricing. It also reflects energy prices coming down,'' said Norbert Ore, chairman of NAPM's business survey committee.

The NAPM index is compiled from a survey of purchasing managers in over 350 manufacturing companies from 20 industries.