By Lucia Mutikani
WASHINGTON (Reuters) - The U.S. economy grew at its fastest pace in almost two years in the third quarter, the government said on Friday as it revised its estimates of business and consumer spending higher.
The upward revisions also extended to exports and suggested some underlying strength in the economy, even though growth in the quarter was largely driven by a buildup in inventories.
The report was supportive of the Federal Reserve's decision this week to reduce by $10 billion from January the $85 billion it is pumping into the economy each month through bond purchases.
"The underlying momentum in economic activity shifted up a gear in the third quarter," said Millan Mulraine, deputy chief U.S. economist at TD Securities in New York. "The strength in domestic consumption and investment activity points to a more constructive narrative on growth than previously thought."
Gross domestic product grew at a 4.1 percent annual rate instead of the 3.6 percent pace reported earlier this month, the Commerce Department said in its third estimate.
That was the quickest pace since the fourth quarter of 2011 and an acceleration from the April-June quarter's 2.5 percent. Third-quarter growth was first estimated at a 2.8 percent rate.
Stocks on Wall Street rose on the data, putting the Standard & Poor's 500 index <.SPX> on pace for its biggest weekly gain in five months. The dollar briefly hit a five-year high against the yen, but later gave up gains. U.S. Treasury debt prices were up.
The data added to other reports such as employment and industrial production that have suggested the economy is on a firmer footing and better able to withstand an anticipated slowdown in stock building this quarter.
DOMESTIC DEMAND RAISED
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, was raised 0.6 percentage point to a 2.0 percent rate. The revisions reflected higher spending on both goods and services than previously estimated.
There was stronger spending on health care and recreation. That lifted spending on services to a 0.7 percent rate, instead of the flat reading that was reported early this month. Spending on goods was bumped up by four tenths of a percentage point.
"The consumer is back in the game," said Chris Rupkey chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York. "They are taking care of themselves, spending more on healthcare, spending more on recreation, and driving around more, buying more gasoline,"
Consumer spending grew at a 1.8 percent rate in the second quarter. Despite the pick-up in consumer spending, inflation remained contained. An inflation gauge in the government's GDP report rose at a 1.9 percent rate, instead of the 2.0 percent rate reported early this month.
A core measure that strips out food and energy costs was also revised down to a 1.4 percent rate from a 1.5 percent rate.
There were upward revisions to business spending, which was raised 1.3 percentage points to a 4.8 percent rate. That reflected stronger growth in intellectual property products such as software, research and development, and entertainment.
The fairly upbeat consumer and business spending outcomes left domestic demand rising at a 2.3 percent rate, instead of the 1.8 percent pace reported earlier this month. That was the fastest pace since the first quarter of last year.
Export growth was also raised up by two tenths of a percentage point to a 3.9 percent pace.
Spending on residential construction was lowered by 2.7 percentage points to a 10.3 percent rate in the third quarter.
A large build-up of stocks still accounted for much of the increase in GDP growth in the July-September quarter.
That has left economists anticipating a slowdown in the pace of inventory accumulation, which would hurt fourth-quarter growth, already expected to take a hit from a 16-day government shutdown in October.
Businesses accumulated $115.7 billion worth of inventories in the third quarter. So far there is little sign that businesses are pulling back, with stocks at retailers, auto dealerships and wholesalers increasing solidly in October.
Some economists say the inventory drag on GDP could be delayed until the first quarter of 2014, while others believe the third-quarter stock pile-up was probably planned.
"The sharp run-up in production in recent months suggests that the pullback from inventories may be smaller than we had first assumed, but it still is likely to dampen growth," said Peter D'Antonio, an economist at Citigroup in New York.
An inventory drag in the first three months of 2014 is likely to be offset by some loosening of fiscal policy.
(Reporting by Lucia Mutikani; Additional reporting by Richard Leong in New York; Editing by Andrea Ricci)