WASHINGTON (Reuters) - The U.S. unemployment rate soared to 8.5 percent last month, a 25-year high, as employers slashed jobs and cut workers’ hours to the lowest level on record, the government said on Friday.

In a report underscoring the economy’s distress, the Labor Department said employers slashed 663,000 jobs in March and revised prior data to show job losses of 741,000 in January, the biggest decline since October 1949. February’s drop in non-farm payrolls was unrevised at 651,000.

But coming in the wake of recent economic data that has surprised on the upside, the report did little to alter perceptions that the economy’s downward momentum is slowing, as unemployment tends to peak well after a recession ends.

The economy, now in its 16th month of recession, remained on track to recover in the second half of this year and the intense phase of job losses is likely over, economists said.

“I don’t think the recovery for the end of this year is derailed by this jobs report. These are lagging indicators. Job losses are down significantly from January, which may very well be the peak,” said Bernard Baumohl, chief global economist at the Economic Outlook Group in Princeton, New Jersey.

U.S. stocks initially fell on the data but reversed course to end higher, cheered by solid earnings from BlackBerry maker Research in Motion and comments from Federal Reserve Chairman Ben Bernanke on efforts to stabilize banks. The Dow Jones industrial ended up 39.51 points at 8,017.59.

Government bond prices fell sharply, as some traders had braced for an even weaker jobs report.

Economists had expected non-farm payrolls to fall by a slightly less severe 650,000 jobs in March, but had anticipated the jump in the jobless rate from February’s 8.1 percent.

The March unemployment rate was the highest since November 1983, when the economy was recovering from the back-to-back recessions of 1980 and 1981, the latter lasting 16 months.

Since the start of the current downturn in December 2007, the economy has shed 5.1 million jobs, with about two-thirds of the losses occurring in the last five months, the department said. In the first quarter of 2009, 2 million jobs were lost.

WORST OF JOB LOSSES LIKELY OVER

“What we saw today may indicate the intense portion of job declines may have reached its nadir,” said Joseph Brusuelas, an economist at Moody’s Economy.com in West Chester, Pennsylvania. “The fact that weekly jobless claims continue to increase and we have further auto cuts in front of us creates some risk.”

To combat the deep recession, which is on track to become next month the longest downturn since the Great Depression, the government has put in place a $787 billion package of tax cuts and spending. In addition, the Federal Reserve has pumped trillions of dollars into the economy.

A man looks at a list of employers at the 2009 CUNY Big Apple Job Fair at the Jacob K. Javits Convention Center in New York, March 20, 2009. REUTERS/Shannon Stapleton

Christina Romer, the head of the White House Council of Economic Advisers, called the job figures “unquestionably horrible.” She told Reuters Television the economy should be growing by the year’s end, but that jobs growth would lag.

“As painful as it is to say, you have to be a little bit patient, that is unfortunately where we are,” she said. “We are taking every action we can to make sure we don’t see numbers like this a few months from now.”

Job losses in March were broad-based. Even government payrolls, normally resilient during downturns, contracted -- the first drop since December. Only education and health services added jobs.

The manufacturing sector shed 161,000 jobs last month, after eliminating 169,000 positions in February. Construction payrolls fell 126,000 after a 107,000 loss in February, and the service sector axed 358,000 positions after cutting 366,000.

The report showed it has become increasingly difficult to find new jobs, with the number of Americans experiencing long spells of joblessness rising by 265,000 to 3.2 million. Nearly one in four of the unemployed had been jobless for 27 weeks or more, the highest ratio since mid-1983.

Rising unemployment is cutting into household incomes, which already have been decimated by the collapse in housing and stock prices, restricting consumers’ spending ability.

A separate report showed activity in the service sector, which represents about 80 percent of U.S. economic activity, shrank for a sixth straight month in March. The Institute for Supply Management’s services index slipped to 40.8 from 41.6 in February, indicating a deepening contraction.

In the jobs report, a measure of unemployed people working part-time for economic reasons and those who have given up looking for work hit a record rate of 15.6 percent from 14.8 percent in February.

The length of the average work week fell to 33.2 hours in March, the lowest on records dating back to 1964, from 33.3 hours the prior month, suggesting further job losses ahead and erosion of first-quarter output.

While payrolls generally lag the rest of the economy, economists cautioned that continued steep job losses could outweigh government efforts to resuscitate the economy.

“The fiscal stimulus will be overwhelmed if the job market does not begin to stabilize in the coming months. We will be keeping a close eye on jobless claims,” said Ethan Harris, co-chief U.S. economist at Barclays Capital in New York.