WRAPUP 4-U.S. economy contracts as consumers retreat

* U.S. economy suffers biggest fall in seven years

* Consumer spending pullback key factor in GDP decline

* Analysts warn contraction to be deep and prolonged (Adds comments by San Francisco Fed president, updates with closing market prices)

By Glenn Somerville

WASHINGTON, Oct 30 (Reuters) - The U.S. economy suffered its sharpest contraction in seven years in the third quarter as consumers cut spending and businesses reduced investment at the onset of what may be a severe and long-lasting recession.

The Commerce Department said on Thursday that U.S. gross domestic product shrank at a 0.3 percent annual rate as the biggest pullback by consumers since 1980 overwhelmed an increase in government spending.

San Francisco Federal Reserve Bank President Janet Yellen called the economy's recent performance "deeply worrisome," and said the downturn was set to worsen.

"For the fourth quarter, it appears likely that the economy is contracting significantly," Yellen said, adding "the bottom is not yet in sight" for slumping housing prices. For details, see [ID:nN30284413]

The typical definition of a recession is consecutive quarters of shrinking national output, a condition that would be met if fourth quarter GDP declines as anticipated, though analysts already expect the slump to last nine months or more.

The drop in GDP was widely expected but the decline was not as great as feared, soothing the angst of investors who bid U.S. stocks up in the hope that interest-rate cuts by central banks around the globe can ward off a deeper downturn.

Despite the date, the blue-chip Dow Jones industrials .DJI ended the day up 2.1 percent.

American voters go to the polls on Tuesday to elect the next U.S. president, and a run of gloomy economic news has given Democratic candidate Sen. Barack Obama an edge over Republican rival Sen. John McCain in the polls.

While the White House conceded the economy had "weakened substantially," it insisted measures it has initiated, like a plan to buy troubled mortgage assets from banks, should help ease credit-market woes, which have cast a cloud worldwide.

Paul Ashworth, senior U.S. economist for London-based Capital Economics Ltd, said he now expects the U.S. economy to shrink 1.5 percent next year, with no growth in 2010.

"Overall, we expect the level of GDP to shrink by a total of 2.5 percent, which would make this one of the worst recessions since the Great Depression," Ashworth said.

CONSUMERS FALTER