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.
Previously, the government had said the economy contracted at a 2.9 percent rate at the start of the year. The second quarter's expansion was much stronger than the 3.0 percent economists had expected and bolstered the outlook for the remainder of the year.
"The economy came back and even though there may have been a little extra inventory building ... solid activity was so widespread that you cannot call this number an aberration," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.
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.
U.S. stocks initially rose on the growth data before faltering, while the dollar hit a 10-month high against a basket of currencies.
Prices for U.S. Treasury debt fell, with the yield on the two-year note touching its highest level since 2011 as traders speculated about an early interest rate increase from the Federal Reserve.
EYES ON THE FED
The GDP data was released only hours before Fed officials were to end a two-day policy meeting.
The U.S. central bank is expected to announce further reductions to the amount of money it is injecting into the economy through monthly bond purchases, but it is not expected to raise rates until June of next year.
"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 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, a welcome development for Fed officials who have long worried about inflation being too low.
A price index in the 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 Fed targets 2 percent inflation.
"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)