U.S. economy gains momentum, may spur Fed to trim stimulus

By Lucia Mutikani

WASHINGTON (Reuters) - U.S. economic growth unexpectedly accelerated in the second quarter, laying a firmer foundation for the rest of the year that could bring the Federal Reserve a step closer to cutting back its monetary stimulus.

Gross domestic product grew at a 1.7 percent annual rate, the Commerce Department said on Wednesday, stepping up from the first quarter's downwardly revised 1.1 percent expansion pace.

The economic picture was further brightened by the ADP National Employment Report, which showed private employers added 200,000 jobs in July, maintaining June's pace. It offered hope the government's comprehensive employment report on Friday could show a recent run of fairly strong job gains extended to July.

"The economy is improving and the ADP report is emblematic of a pattern of growth that will continue to tilt to the upside," said Eric Green, chief economist at TD Securities in New York. "That is enough for the Fed to taper in September."

Economists polled by Reuters had forecast the economy growing at a 1.0 percent pace after a previously reported 1.8 percent advance in the first three months of the year.

Fed officials at the end of a two-day meeting said the economy still needed monetary support, and offered no indication they planned to reduce their monthly $85 billion in bond purchases at their next meeting in September.

Economists, however, said the Fed statement appeared aimed at keeping market-set interest rates tamped down.

"We continue to expect the (Fed) to taper the asset purchase program in September," said Dean Maki, chief U.S. economist at Barclays in New York.

Fed Chairman Ben Bernanke said last month that the U.S. central bank would probably start curtailing bond purchases later this year with an eye toward bringing them to a halt by the middle of 2014 if the economy progressed as expected.

The dollar fell against a basket of currencies after the Fed's statement, surrendering earlier gains from the GDP report, while U.S. Treasury debt prices reversed losses. Stocks on Wall Street were trading higher in late afternoon.

Rebounds in business spending and export growth and a sharp moderation in the pace of decline in government outlays boosted economic growth in the April-June period, offsetting cooler consumer spending and a steady rate of inventory accumulation.

Still, the report marked a third straight quarter of GDP growth below 2 percent, a pace that normally would be too soft to bring down unemployment. But growth was poised to gain even more momentum in the second half of the year as the fiscal burden brought on by belt-tightening in Washington eases.

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Graphic-U.S. GDP: http://link.reuters.com/tut99t

Graphic-Contributors to GDP: http://link.reuters.com/xut99t

Graphic-U.S. mortgages: http://link.reuters.com/guv37s

Graphic-ADP employment report: http://link.reuters.com/fex44t

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REVISIONS GIVE ECONOMY A GLOW

Revisions to earlier GDP data released along with the report on Wednesday cast the economy in a better light than previously, and contributed to the report's solid tenor.

The government implemented a number of changes in how it calculates GDP. For example, research and development spending will now be treated as investment, and defined benefit pension plans will be measured on an accrual basis, rather than as cash.

The revisions showed the economy grew 2.8 percent last year, 0.6 percentage point faster than previously estimated.

They also yielded a higher rate of savings, a good omen for future consumer spending.

Still, higher taxes, as Washington tries to shrink the government's budget deficit, constrained consumer spending in the second quarter. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, slowed to a 1.8 percent growth pace after rising at a 2.3 percent rate in the first quarter.

The slow pace of consumption kept a lid on inflation pressures, with a price index in the report holding steady in the second quarter. Excluding food and energy, prices rose at a subdued 0.8 percent pace. Both measures were the weakest since the first quarter of 2009.

Tepid domestic demand also led businesses to keep close watch on their inventories. Inventory accumulation added 0.41 percentage point to growth, less than half its contribution in the prior quarter.

But higher savings and a firming labor market should help to spur consumer spending and encourage businesses to continue a steady pace of restocking.

"We remain confident that the economy will expand much faster in the second half of the year as the drag from fiscal tightening continues to fade," said Harm Bandholz, chief U.S. economist at UniCredit Research in New York.

"The most important support factor will remain the improving labor market, which already in the past has allowed consumer spending to weather most of the fiscal drag."

Private employers added 200,000 jobs in July after hiring 198,000 in June, the ADP report showed. The figure was in line with the pace of job growth seen since the start of the year.

Exports rebounded in the second quarter, showing the largest percentage gain since the third quarter of 2011, even as demand weakened in Europe and China.

But the increase was insufficient to offset strong import growth, leaving a trade deficit that weighed on GDP.

There was good news from the housing sector, with spending on residential construction rising at a double-digit rate. Housing, which triggered the 2007-09 recession, is growing strongly, helping to keep the economic recovery anchored.

However, a rise in mortgage rates on the back of growing expectations of a reduction in the Fed's bond purchases has cooled the appetite of some potential buyers.

Business spending reversed the prior quarter's decline, and while government spending contracted for a third straight quarter, the pace of the decline slowed sharply as state and local government spending rebounded. (Reporting by Lucia Mutikani, Additional reporting by Leah Schnurr in New York; Editing by Andrea Ricci and James Dalgleish)