U.S. Economy: Growth Unexpectedly Accelerated (Update4)

By Bob Willis

Oct. 31 (Bloomberg) -- Economic growth in the U.S. unexpectedly accelerated in the third quarter as increases in exports, consumer spending and business investment made up for another plunge in home construction.

Gross domestic product grew at an annual rate of 3.9 percent, the most in more than a year, the Commerce Department said today in Washington. The quarter included the period when some mortgage and commercial-borrowing costs jumped to six-year highs, prompting economists to cut their growth forecasts, and some to even warn of recession.

Federal Reserve policy makers today cut the benchmark lending rate by a quarter point to 4.5 percent and signaled they may have already done enough to prevent the economy from stalling. Third-quarter growth was ``solid'' and financial market strains ``eased somewhat,'' the Fed said. Stocks advanced and Treasury notes fell.

``It depends on how the economy unfolds as to whether they'll reduce rates again,'' said Brian Bethune, senior financial economist at Global Insight, a research firm in Lexington, Massachusetts. ``Certainly we got a pretty good GDP report; that is something that influenced them to a neutral position.''

Market Reaction

The yield on the benchmark 10-year note rose to 4.46 percent at 4:06 p.m. in New York, from 4.38 percent late yesterday. The Dow Jones Industrial Average climbed 1 percent to 13,930.01.

The collapse in subprime lending caused the average rate on one-year adjustable mortgages to shoot up to 5.84 percent in late August, the highest since June 2001, according to figures from Freddie Mac. The rate on one-day asset-backed commercial paper rose to the highest since January 2001.

Consequently, home purchases and construction slumped at the end of the quarter. Existing home sales in September fell 8 percent from the prior month, while housing starts declined 10 percent to the lowest since March 1993, reports earlier this month showed.

The National Association of Purchasing Management-Chicago said its business-activity index fell to 49.7 in October, from 54.2 the previous month. Readings below 50 signal a contraction. The median forecast among economists surveyed by Bloomberg News was for a drop to 53.

Job Gain

Companies in the U.S. added 106,000 jobs in October, more than economists had forecast, according to a report today from ADP Employer Services. A report from the Labor Department also showed employment costs rose in the third quarter at a slower pace than in the previous three months, suggesting increases in wages and benefits aren't heating up inflation. Additional figures from the Commerce Department showed construction spending increased last month as the building of factories, hotels and schools compensated for a drop in housing.

The GDP report is the first for the quarter and will be revised in November and December as more information becomes available. The median forecast in a Bloomberg News survey was for an expansion of 3.1 percent.

The Fed's preferred inflation gauge, which is tied to consumer spending and strips out food and energy costs, rose at a 1.8 percent annual pace following a 1.4 percent increase the prior quarter, according to the report.

The gain leaves prices within the 1 percent to 2 percent range policy makers, including Ben S. Bernanke before becoming Fed chairman, have said is their preferred zone.

Price Slowdown

The GDP figures are adjusted for inflation and the acceleration in growth came in part because of the smallest gain in overall prices since 1998. The report's price index rose at a 0.8 percent annual rate after a 2.6 percent second-quarter rise.

Consumer spending grew at a 3 percent pace following a 1.4 percent increase in the prior quarter, contributing the most to the gain in growth. Still, many economists project spending will slow as declining property values turn Americans pessimistic.

``I don't expect we're going to see GDP at all like this in the fourth quarter, but coming from where we've been in mid- 2007, it won't be bad,'' said Richard DeKaser, chief economist at National City Corp. in Cleveland, who forecast growth of 3.8 percent.

The economy will probably expand at a 1.8 percent pace in the current quarter, according to the median forecast of economists surveyed earlier this month.

Investment Increases

Consumers weren't the only ones buying last quarter. Gains in both commercial construction projects and purchases of equipment and software contributed to a 7.9 percent increase in business investment. The 5.9 percent rise in spending on new equipment was the biggest since the first quarter of 2006.

An increase in inventories contributed another 0.4 percentage point to growth.

The economy was also buttressed by a narrowing of the trade deficit that added 0.9 percentage point to the rate of expansion. The gap shrank to $546.2 billion at an annual pace, the smallest since the last three months of 2003.

General Electric Co.'s third-quarter profit rose as large- equipment orders climbed 39 percent amid a surge in demand from countries that are building airports and power grids, the Fairfield, Connecticut-based company said Oct. 12.

``We see orders everywhere around the world,'' GE's Chief Executive Officer Jeffrey Immelt said on a conference call earlier this month. ``That seems to be accelerating, not diminishing.''

Home construction remained the biggest drag on GDP, the report showed. A 20.1 percent plunge in homebuilding, the seventh consecutive decline, subtracted a percentage point from growth.