Third-quarter growth cut on weak inventories

A worker prepares to install a door on the new Chevrolet Cruze car as it moves along the assembly line at the General Motors Cruze assembly plant in Lordstown, Ohio July 22, 2011.

WASHINGTON (Reuters) - The U.S. economy grew more slowly than previously estimated in the third quarter, but a drawing down of stocks held by companies and firm consumer spending suggested output would pick up in late 2011.

Gross domestic product grew at a 2.0 percent annual rate in the July-September quarter, the Commerce Department said in its second estimate on Tuesday, down from the previously reported 2.5 percent.

While the pace of growth was weaker than economists had expected, the composition of the report, particularly still-firm consumer spending and the first drop in businesses inventories in nearly two years, set the stage for a stronger performance in the final months of the year.

A deterioration in consumer sentiment likely had led businesses to anticipate weaker demand. With consumer spending showing resilience, analysts said they will now have to rebuild inventories, keeping factories busy.

"The mix or composition of growth improved. Inventory investment was lower so firms are more likely to produce more goods going forward. And exports rose," said Cary Leahey, a senior economist at Decision Economics in New York.

"So while you lost a half-percentage point in the revision to third-quarter growth, you might easily get it back in the fourth quarter of this year or the first quarter of next."

Data so far suggest the fourth-quarter growth pace could exceed 3 percent, which would be the fastest in 18 months.

U.S. stocks closed down for a fifth straight day as borrowing costs in Spain scaled another record high, underscoring the magnitude of the euro zone debt crisis.

Prices for long-dated U.S. Treasury debt rallied, while the dollar was little changed against a basket of currencies.

INVENTORIES A DRAG

Despite the downward revision, last quarter's growth is still a step up from the April-June period's 1.3 percent pace.

The government revised third-quarter output to account for an $8.5 billion drop in business inventories, the first decline since the fourth quarter of 2009.

The drop in inventories lopped off 1.55 percentage points from GDP growth, which was partly offset by strong exports.

Excluding inventories, the economy grew at an unrevised brisk 3.6 percent pace after expanding 1.6 percent in the second quarter.

Consumer spending was taken down a notch to a 2.3 percent growth pace from 2.4 percent, but remained the quickest pace since the fourth quarter of 2010.

But weak income growth could crimp spending going forward. Taking inflation into account, disposable income fell at a steeper 2.1 percent rate instead of 1.7 percent, the report showed. It had declined 0.5 percent in the prior three months.

The failure of a congressional "super committee" to agree on a deficit reduction package of at least $1.2 trillion also clouds the outlook. It is less clear now that Congress will extend a payroll tax cut and emergency unemployment benefits due to expire next month.

That potential fiscal drag, together with the festering European debt crisis, could undermine growth early next year and prompt further monetary stimulus from the Federal Reserve.

Minutes of the U.S. central bank's November 1-2 policy meeting published on Tuesday showed a few Fed officials believed the outlook for modest growth might warrant more policy easing.

"The complete failure of Washington to make any meaningful changes to spending or taxes could further harm confidence of both consumers and businesses," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

"So we could get a really good fourth-quarter growth rate but much more modest gains in 2012, and that will weigh on investors and keep the Fed pushing as hard as it can, even if it is a string that it is pushing."

REVERSAL OF TEMPORARY FACTORS

Part of the pick-up in output during the last quarter reflected a reversal of factors that held back growth earlier in the year.

A jump in gasoline prices had weighed on spending in the first half of the year, and supply disruptions from Japan's big earthquake and tsunami in March had curbed auto production.

Business investment was revised down to a 14.8 percent rate from 16.3 percent as estimates for investment in nonresidential structures and outlays on equipment and software were lowered.

The department also said after-tax corporate profits increased at a 3.0 percent rate after rising 4.3 percent in the second quarter.

Exports grew at a stronger 4.3 percent rate instead of 4.0 percent, while imports rose at a much slower 0.5 percent rate rather than 1.9 percent.

Elsewhere, there were revisions to show modest residential construction growth and weak government spending.

The GDP report also showed inflation pressure subsiding, with a price index for personal spending rising at a 2.3 percent rate, instead of 2.4 percent. That compared to a 3.3 percent rate in the second quarter.

A core inflation measure, which strips out food and energy costs, rose at a 2.0 percent rate rather than 2.1 percent. The measure -- closely watched by the Federal Reserve -- grew at a 2.3 percent rate in the prior three months.

(Additional reporting by Ellen Freilich in New York; Editing by Chizu Nomiyama)