U.S. services sector activity hit an 8-1/2 year high last month and factory orders surged in June, bolstering expectations of solid economic growth in the third quarter.

Tuesday's reports added to employment and consumer spending data in suggesting sustained momentum in the economy that could bring the Federal Reserve closer to raising interest rates.

"The economy is normal, and a normal economy requires a normal interest rate, not a zero interest rate," said Chris Rupkey, chief financial economist at MUFG Union Bank in New York.

The Institute for Supply Management's services index rose to 58.7 last month from 56.0 in June. While the index only dates to 2008, an examination of subcomponents with a longer track record indicate that was the highest level of activity since December 2005. A reading above 50 indicates expansion.

Activity in the sector, which accounts for more than 80 percent of the U.S. economy, was boosted by a jump in orders, which touched their highest point in nearly nine years.

A sub-index gauging services industry employment also rose as did order backlogs, but export order growth moderated.

In a separate report, the Commerce Department said orders for manufactured goods increased 1.1 percent in June, more than reversing May's 0.6 percent decline. Orders for non-defense capital goods excluding aircraft - a measure of business confidence and spending plans - hit a record high.

Strong business investment is one of the key ingredients needed for robust economic growth and the surge will be welcomed by Fed officials as they weigh the course of monetary policy.

Interest rate futures now point to a better-then-even chance the U.S. central bank will hike overnight rates in June of next year. It has held them near zero since December 2008.

"We think the Fed will revise its guidance on the outlook for interest rates at the September policy meeting, leaving the door open for a rate hike as soon as March 2015," said John Ryding, chief economist at RDQ Economics in New York.

FIRING ON ALL CYLINDERS

The data helped lift the U.S. dollar to a 10-1/2 month high against a basket of currencies, while prices for U.S. Treasury debt fell. U.S. stocks fell as retailer Target (TGT.N) cut its second-quarter earnings estimate.

A wealth of data have suggested the economy is firing on almost all cylinders. But businesses amassed huge piles of stocks in the second quarter, which they may need to work through before placing more orders.

That could take some edge off growth in the third quarter. The economy grew at a 4.0 percent annual pace in the April-June period, and growth estimates for the third quarter are currently around a 3 percent rate.

In June, factory orders rose across all categories, with bookings for electrical equipment, appliances and components recording their largest gain since November 2010.

In another sign of strength, unfilled orders saw their largest rise in seven months. Orders for durable goods, which are expected to last three years and more, were revised to show a sturdy 1.7 percent gain instead of the previously reported 0.7 percent advance.

Orders for non-defense capital goods excluding aircraft increased 3.3 percent. These so-called core capital goods orders were previously reported to have increased 1.4 percent.