Shrinking U.S. trade gap shows economy's underlying strength

By Lucia Mutikani

WASHINGTON (Reuters) - The U.S. trade deficit fell in July to its lowest level in five months as exports rose broadly, signaling underlying strength in the economy amid concerns about a global growth slowdown.

While other data on Thursday showed an increase in the number of Americans filing new applications for unemployment benefits, the trend in jobless claims remained consistent with a strengthening labor market. Activity in the vast services sector also hovered at a 10-year high in August.

"There is little evidence that the abrupt deterioration in financial market conditions and the heightened concerns about the global economy have begun to affect the U.S. economy," said Ryan Sweet, a senior economist at Moody’s Analytics in West Chester, Pennsylvania.

The Commerce Department said the trade gap narrowed 7.4 percent to $41.9 billion, the smallest since February. When adjusted for inflation, the deficit fell to $56.2 billion from $59.0 billion in the prior month.

The smaller deficit implied a modest contribution to gross domestic product from trade early in the third quarter. Trade added 0.3 percentage point to the economy's 3.7 percent annualized growth rate in the second quarter.

Data ranging from consumer spending to employment and housing have suggested the economy retained much of its momentum from the second quarter and was on solid footing when global financial markets were rocked by turbulence triggered by worries over China's economy.

Stocks on Wall Street were trading higher after the data. Investor sentiment also was boosted after the European Central Bank indicated it could prolong its monetary stimulus program.

The dollar rose against a basket of currencies, while prices for longer-dated U.S. Treasuries fell.

In a separate report, the Labor Department said initial claims for state unemployment benefits increased 12,000 to a seasonally adjusted 282,000 for the week ended Aug. 29.

The claims data has no bearing on Friday's closely watched employment report for August as it fell outside the survey period. According to a Reuters survey of economists, nonfarm payrolls likely increased by 220,000 last month after rising 215,000 in July.

But job gains could come in below expectations as the first reading of August payrolls has tended to be weaker in the last several years before being revised higher.

EYES ON FED

The August employment report will be released less than two weeks before the Federal Reserve's Sept. 16-17 policy-setting meeting. There is speculation the U.S. central bank could raise interest rates at that meeting.

The four-week moving average of claims, considered a better measure of labor market trends as it irons out week-to-week volatility, rose 3,250 to 275,500 last week.

It was the 23rd straight week that the four-week average remained below the 300,000 threshold, which is usually associated with a strengthening labor market.

A third report from the Institute for Supply Management showed its services industry index slipped to 59 last month from a reading of 60.3 in July, which was the highest since August 2005. A reading above 50 indicates expansion in the sector.

Fifteen out of 18 service industries, including real estate, construction and retail trade, reported an expansion in activity - the most since October. Only mining reported a contraction.

"The domestic economy is holding strong. The Fed must weigh this against the prospects of a weakening global economy as they decide whether to raise interest rates in two weeks," said Jay Morelock, an economist at FTN Financial in New York.

The strong services sector should help offset the drag on the economy from manufacturing, which has been hit by a strong dollar and spending cuts by energy companies.

But the buoyant dollar's negative impact on the economy is starting to ease. Exports increased 0.4 percent to $188.5 billion in July, the first rise since April. There were increases in exports of food, industrial supplies and materials, and capital goods in July. Automobile exports also rose.

Imports fell 1.1 percent to $230.4 billion, led by consumer goods such as pharmaceuticals and cell phones. However, automobile imports were the highest on record and the value of crude oil imports was the highest since January.

Soft import growth is usually associated with sluggish domestic demand. The weakness, however, is probably related to a slowdown in inventory accumulation as businesses try to whittle down a huge stockpile of merchandise accumulated in the first half of 2015.

The politically sensitive U.S.-China trade deficit was $31.6 billion in July, up 0.4 percent from June. That trade gap will be closely watched in the coming months in the wake of China's recent devaluation of its currency.

Exports to Canada fell 8.3 percent in July and could come under more pressure after the Canadian economy slipped into recession in the second quarter.

(Reporting by Lucia Mutikani; Editing by Paul Simao)