WASHINGTON (Reuters) - The economy grew at its fastest pace in a year in the third quarter as consumers and businesses stepped up spending, creating momentum that could carry into the final three months of the year.
The expansion was a welcome relief for an economy that looked on the brink of recession just weeks ago, although part of the pick-up came from a reversal of factors that held back growth earlier in the year, and analysts worry about 2012.
U.S. gross domestic product grew at a 2.5 percent annual rate in the third quarter, up from a 1.3 percent pace in the prior three months, the Commerce Department said on Thursday. That took output back to pre-recession level.
While the growth pace matched economists' forecasts, domestic demand showed a bit more vigor than most had expected.
"The economy is now heading in the right direction and this is very encouraging, particularly given the heightened global uncertainties and the fact that other major economies appear to be heading into recessions," said Millan Mulraine, a senior macro strategist at TD Securities in New York.
An agreement by European leaders to ramp up their debt crisis response combined with the data to spark a rally on Wall Street. U.S. stocks closed more than 3 percent higher.
Prices for Treasury debt fell, with benchmark yields rising to a 2-1/2-month high. The dollar recorded its biggest one-day fall against a basket of currencies in 2-1/2 years.
The GDP report could give some breathing space for Federal Reserve policymakers who meet next week to debate additional ways to help the economy and lower an unemployment rate that has been stubbornly stuck above 9 percent for five months.
The economy needs to grow at a rate of more than 2.5 percent over a sustained period to cut the jobless rate.
"The persistence of high unemployment and ongoing fragility of the economy ... will prompt the Fed to take more unconventional actions as we move into 2012," said Diane Swonk, chief economist at Mesirow Financial in Chicago.
For the U.S. economy, the biggest problem is the weakness of the labor market. Inflation-adjusted disposable income fell at a rate of 1.7 percent in the third quarter -- the first decline since the fourth quarter of 2009 -- and consumers had to dip into savings to lift their spending.
"People are not doing well. I don't know anybody who's better off now than he was a year ago," said Jose Lopez, a 67-year-old Miami construction engineer who lost his job early this month. "It's just the bare basics," he said as he emerged from a discount shopping store in West Miami.
A jump in gasoline prices had weighed on consumer spending earlier in the year, and supply disruptions from Japan's big earthquake and tsunami in March had curbed auto production.
As those factors faded, the U.S. economy perked up.
Consumer spending grew at a 2.4 percent rate in the third quarter, the strongest since the fourth quarter of 2010, while business investment spending shot up at a 16.3 percent pace, the most in more than a year.
Failing to anticipate the fairly strong demand, businesses were slow to restock warehouses. Inventories posted their smallest gain since the fourth quarter of 2009, a slowdown that subtracted more than 1 percentage point from GDP growth.
Excluding the drag from inventories, the economy grew at a brisk 3.6 percent pace.
The peppier spending and sluggish pace of inventory growth lays the base for a solid fourth quarter but the possibility of another recession in Europe and the exhaustion of pent-up U.S. demand could leave a weak spot early in 2012.
The jobs market is showing little improvement. Data from the Labor Department on Thursday showed new claims for state unemployment benefits fell 2,000 last week to 402,000, a level that suggests little headway.
Households, however, should get some relief as price pressures abate. A price index for personal spending rose at a 2.4 percent rate in the third quarter, slowing from the April-June quarter's 3.3 percent pace.
A core inflation measure, which strips out food and energy costs, rose at a 2.1 percent rate after increasing 2.3 percent in the prior three months.
Apart from consumer and business spending, growth in the third quarter was also supported by a smaller U.S. trade deficit.
Spending on residential construction also rose modestly.
Still, there are no signs of a real housing recovery. A report from the National Association on Realtors on Thursday showed pending sales of previously owned homes fell for a third successive month in September.
Government spending was flat in the third quarter, reflecting continued budget cuts by state and local governments.
While the pace of decline in state and local government spending is now moderating, economists worry fiscal policy will tighten next year if Congress fails to extend expiring payroll tax cuts and emergency jobless benefits.
"Fiscal tightening and policy uncertainty will weigh on growth. We expect growth to slow from 2.0 percent in the first half of next year to a 1 percent handle by year-end," said Michelle Meyer, an economist at Bank of America Merrill Lynch in New York.