By Lucia Mutikani
WASHINGTON (Reuters) - U.S. economic growth slowed slightly more than initially thought in the fourth quarter after the strongest pace of consumer spending in three years depleted inventories and drew in imports as businesses struggled to produce enough goods and services.
Gross domestic product expanded at a 2.5 percent annual rate in the final three months of 2017, instead of the previously reported 2.6 percent pace, the Commerce Department said in its second GDP estimate on Wednesday. That was a deceleration from the third quarter's brisk 3.2 percent pace.
(For an interactive graphic on U.S. GDP click http://tmsnrt.rs/1jLPbzV)
The downward revision to the fourth-quarter growth estimate largely reflected a smaller inventory build than previously reported. The reliance on imports to satisfy domestic demand could further widen the trade deficit and blunt the anticipated economic boost from a $1.5 trillion tax cut package and increased government spending.
Domestic demand grew at an unrevised 4.6 percent rate in the fourth quarter, the fastest pace in more than three years.
"An economy that is at or beyond full employment ... cannot match this pace of demand growth and, therefore, must either sell from inventory and/or purchase from abroad," said John Ryding, chief economist at RDQ Economics in New York.
The trade deficit is likely to worsen in the first quarter. Data on Tuesday showed the goods trade deficit widened sharply in January as exports fell, pointing to slower economic growth in the first three months of the year.
The moderation in GDP was also underscored by other reports on Wednesday showing factory activity in the Midwest slowing to a six-month low in February and contracts to purchase previously owned homes tumbling 4.7 percent in January to the lowest level since October 2014.
Retail sales, home sales, durable goods orders and industrial production have also declined in January.
First-quarter growth tends to be weak because of a seasonal quirk, but output is likely to accelerate for the rest of 2018 as the fiscal stimulus kicks in. GDP growth estimates for the January-March period are as low as a 1.8 percent rate.
The economy grew 2.3 percent in 2017, an acceleration from the 1.5 percent logged in 2016.
Economists believe the economy will hit the Trump administration's 3 percent annual growth target this year, possibly putting pressure on the Federal Reserve to raise interest rates more aggressively than currently anticipated.
Fed Chairman Jerome Powell struck an upbeat note on the economy before U.S. lawmakers on Tuesday, saying "my personal outlook for the economy has strengthened since December." Powell also acknowledged that "fiscal policy is becoming more stimulative." Those remarks prompted traders to raise their bets on four rate increases this year.
The Fed has forecast three rate hikes for 2018. Financial markets expect the first increase to come in March.
"Evidence of a strengthening economy and the potential for further acceleration fueled by fiscal stimulus are likely to keep the Fed on its prescribed tightening path," said Jim Baird, chief investment officer at Plante Moran Financial Advisors in Kalamazoo, Michigan.
The dollar (DXY) rose to a five-week high against a basket of currencies as investors continued to digest Powell's comments.
Prices for longer-dated U.S. government bonds were trading higher, while stocks on Wall Street were mixed.
ROBUST CONSUMER SPENDING
Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity, was unrevised at a 3.8 percent rate in the fourth quarter. That was the quickest pace since the fourth quarter of 2014 and followed a 2.2 percent rate of growth in the July-September period.
The acceleration in consumer spending stoked inflation, with the Fed's preferred measure, the personal consumption expenditures (PCE) price index excluding food and energy, rising at an unrevised 1.9 percent rate. The rise in the so-called core PCE price index was the fastest in more than a year and followed a 1.3 percent pace of increase in the third quarter.
Imports grew at an upwardly revised 14.0 percent pace instead of the previously reported 13.9 percent rate. That was the quickest pace since the third quarter of 2010 and offset a rise in exports driven by weakness in the dollar.
The resulting trade deficit sliced off 1.13 percentage points from GDP growth last quarter, the most in a year, after adding 0.36 percentage point in the third quarter.
Robust consumer spending also curbed the accumulation of inventories, which increased at a rate of $8.0 billion instead of the previously reported $9.2 billion pace. As a result, inventories subtracted 0.70 percentage point from GDP growth after adding 0.79 percentage point in the prior period.
Growth in business spending on equipment was revised up to an 11.8 percent rate from the 11.4 percent pace published last month. That was the best performance since the third quarter of 2014.
The momentum, however, appears to be slowing, with a report on Tuesday showing a second straight monthly decline in core capital goods orders in January.
Investment in homebuilding increased at a 13.0 percent rate, rather than the previously reported 11.6 percent pace, after contracting for two straight quarters. Government spending grew at a 2.9 percent rate, revised down from a 3.0 percent pace. That was the strongest pace since the second quarter of 2015.
