By Lucia Mutikani
WASHINGTON (Reuters) - The U.S. economy rebounded sharply in the second quarter as consumers stepped up spending and businesses restocked, putting it on course to close out the year on solid footing.
Gross domestic product expanded at a 4.0 percent annual rate after shrinking at a revised 2.1 percent pace in the first quarter, the Commerce Department said on Wednesday.
The government previously had said the economy contracted at a 2.9 percent rate at the start of the year.
The second-quarter expansion was much stronger than the 3.0 percent economists had expected and added to manufacturing and services sector data in bolstering the outlook for the remainder of the year.
"Today's report shows greater near-term healing and momentum, reducing the downside risks and leaving us comfortable with our forecast for above 3.0 percent growth through next year," said Michelle Meyer, a senior economist at Bank of America Merrill Lynch in New York.
Despite the pickup, growth in the first half of the year badly lagged the economy's estimated 2 percent to 2.5 percent potential, a reminder that the nation's recovery from the worst recession since the 1930s remains the slowest on record.
A separate report showed private employers added 218,000 jobs to their payrolls this month, a decline from June's hefty gain of 281,000. Still, hiring remains solid and consistent with expectations for a stronger second half of the year.
Federal Reserve officials on Wednesday acknowledged the improvement in the economy, but cautioned that labor market slack remained considerable. The U.S. central bank, following the end of a two-day policy meeting, announced a further reduction to the amount of money it is injecting into the economy through monthly bond purchases.
The Fed is not expected to raise interest rates until next June.
The GDP data buoyed the dollar, lifting it to a 10-month high against a basket of currencies as traders speculated about an early rate hike.
Prices for U.S. Treasury debt fell, with the yield on the two-year note touching its highest level since 2011. U.S. stocks were trading mixed.
ECONOMY IN MUCH BETTER SHAPE
"We do not feel the report calls for pulling forward the Fed rate hike. The first quarter's bad weather didn't change the story, but simply delayed when that train gets to the station," said Tim Hopper, chief economist at TIAA-CREF in New York.
The government also published revisions to prior GDP data going back to 1999, which showed the economy performing much stronger in the second half of 2013 and for that year as a whole than previously reported.
The economy in the second quarter was buoyed by consumer spending and a swing in business inventories.
Consumer spending growth, which accounts for more than two-thirds of U.S. economic activity, accelerated at a 2.5 percent pace, as Americans bought long-lasting manufactured goods, mostly automobiles, and spent a bit more on services.
It had braked to a 1.2 percent pace in the first quarter because of weak healthcare spending.
Despite the pick-up in consumer spending, Americans saved more in the second quarter. The saving rate increased to 5.3 percent from 4.9 percent in the first quarter as incomes rose, which bodes well for future spending.
Inventories contributed 1.66 percentage points to GDP growth after chopping off 1.16 points in the first quarter.
The economy also received a boost from business investment, government spending and investment in home building.
Trade, however, was a drag for a second consecutive quarter as some of the increase in domestic demand was met by a surge in imports. Domestic demand rose at its fastest pace since the third quarter of 2011.
Solid domestic demand, which underscores the economy's firming fundamentals, led to some pick-up in price pressures in the second quarter. The Fed on Wednesday signaled more comfort that inflation was moving up toward its 2 percent target.
A price index in the GDP report rose at a 2.3 percent rate in the second quarter, the quickest in three years, after advancing at a 1.4 percent pace in the prior period.
A core price measure that strips out food and energy costs increased at a 2.0 percent pace, the fastest since the first quarter of 2012.
"The inflation picture should lend support to the Fed hawks who want to hike interest rates sooner rather than later," said Sung Won Sohn, an economics professor at California State University Channel Islands in Camarillo.
(Reporting by Lucia Mutikani; Additional reporting by Richard Leong in New York; Editing by Paul Simao)