Economy ends '06 on slower note

By Joanne Morrison

WASHINGTON (Reuters) - The U.S. economy grew at a tepid 2.2 percent pace at the end of 2006, much weaker than first thought, while new home sales last month had their biggest drop in 13 years, according to data released on Wednesday that showed a soft economy.

Adding to that dreary picture, business activity in the Midwest -- the epicenter of U.S. manufacturing -- slumped in February after contracting in January.

Even with the softer economic data, Federal Reserve Chairman Ben Bernanke reassured markets that the economy was still well positioned for moderate growth.

"We are looking for moderate growth in the U.S. economy," Bernanke told the House Budget Committee on Wednesday. "The downward revision of the fourth-quarter GDP numbers we got this morning is actually more consistent with our overall view of the economy than were the original numbers."

Gross domestic product, the broadest measure of overall economic activity within U.S. borders, expanded at an annual rate of 2.2 percent in the fourth quarter of 2006. That was revised down from the 3.5 percent advance in the government's prior estimate.

Still, the soft economic picture painted by Wednesday's data added to expectations that the Fed is done raising interest rates in its battle over inflation.

"Good data is clearly becoming more sparse and today's reports, if anything, just reinforce the view the Fed is done tightening," said Mark Meadows, currency strategist at Tempus Consulting.

The Commerce Department's latest GDP estimate was slightly weaker than the 2.4 percent increase that economists polled by Reuters were expecting and also suggested there was less risk of inflationary pressures mounting.

As expected, a wider trade deficit also weighed on GDP, as more goods than first estimated were imported.

On the inflation front, the closely watched personal consumption expenditures price index declined by a 0.9 percent rate, the biggest fall since 1954, as energy prices dropped.

The core PCE price index, which strips out volatile food and energy prices and is closely watched at the Fed, rose 1.9 percent, a bit below the 2.1 percent gain first estimated.

"That's a recipe to provide further traction to the notion the Federal Reserve will not need to raise rates further and that its next move is a rate cut," said Alex Beuzelin, senior market analyst at Ruesch International in Washington.

The central bank has held its benchmark official rate steady at 5.25 percent since June. Market expectations were that the Fed will cut the rate by August.

The updated reading on the health of the U.S. economy and the January new home sales data came one day after a global stock market rout in which the blue-chip Dow Jones industrial average .DJI notched its biggest one-day point drop since just after the September 11, 2001, attacks.

U.S. stock markets recovered some of those losses on Wednesday, ending up modestly after Bernanke said there appeared to be no special factors triggering Tuesday's sell-off and that officials were closely monitoring the markets.