By Lucia Mutikani
WASHINGTON (Reuters) - A smaller trade deficit and surge in defense spending buoyed U.S. economic growth in the third quarter, but domestic demand slipped, hinting at some loss of momentum.
Gross domestic product grew at a 3.5 percent annual pace, the Commerce Department said on Thursday. However, the pace of growth in business investment, housing and consumer spending slowed from the second quarter.
"The report was broadly constructive, but with weakness emerging in housing and consumption spending, we expect the pace of growth to slip further in the fourth quarter," said Millan Mulraine, deputy chief economist at TD Securities in New York.
Despite decelerating from the second quarter's robust 4.6 percent growth rate, it was the fourth quarter out of five that the economy has expanded at or above a 3.5 percent clip.
Signs the economy has moved to a healthy growth track have done little to bolster Obama's Democrats, who look to lose control of the Senate in mid-term elections on Tuesday that will be importantly shaped by voters views on jobs and growth.
The third-quarter gain in output outstripped economists' expectations, but growth in domestic demand braked to a 2.7 percent pace after a brisk 3.4 percent gain in the April-June period, giving the report a softer tenor.
A separate report from the Labor Department showed first-time applications for unemployment benefits rose marginally last week, but a measure of underlying trends hit its lowest level since May 2000 in a show of labor market strength.
The data came one day after the Federal Reserve ended its asset purchasing program and said there was sufficient underlying strength in the economy to continue whittling away at unemployment.
The dollar rose against a basket of currencies on the growth data, and U.S. stocks gained. Prices for U.S. Treasury debt also were trading higher.
TRADE, GOVERNMENT SHINE
A narrowing trade gap accounted for the bulk of the rise in GDP last quarter, adding 1.32 percentage points to growth.
Imports fell at their fastest pace since the fourth quarter of 2012 as demand for overseas oil waned. And while export growth softened from the second quarter's double-digit pace, it remained strong even in the face of slowing economies in the euro zone and China.
Government spending also provided a boost to GDP, with defense spending adding 0.66 percentage point to growth. The 16 percent growth rate of defense spending, its fastest in five years, reflected stepped-up spending on ammunition and jet fuel.
Economists said the purchases were likely related to the ongoing air strikes against Islamic State militants in Syria and Iraq.
"In this case we shouldn't expect complete payback in the GDP numbers, but even so, some modest pullback in government spending seems likely this quarter," said Michael Feroli, an economist at JPMorgan in New York.
A slowdown in inventory building weighed on growth, and economists warned that pressure would likely persist into the fourth quarter.
Growth estimates for the final quarter of the year are currently ranging between a 2.5 percent and 3 percent pace.
BUSINESS SPENDING SLOWS
Growth in business investment slowed in the third quarter, with spending on equipment falling short of expectations even as it remained strong. Data on Tuesday suggested equipment spending could slow further in the fourth quarter.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, decelerated to a 1.8 percent growth pace from the second-quarter's 2.5 percent rate.
The slower pace of consumer spending helped keep inflation under wraps, with two price indexes in the GDP report slowing sharply.
Declining gasoline prices and accelerating job growth, which is expected to lift wages, will provide tailwinds for consumer spending that should keep growth on track in the fourth quarter.
(Reporting by Lucia Mutikani; Editing by Andrea Ricci)