The U.S. economy gathered speed in the fourth quarter to regain its pre-recession peak with a big gain in consumer spending and strong exports, removing doubts about the recovery's sustainability.
The economy grew at a 3.2 percent annual rate in the final three months of 2010, after expanding at a 2.6 percent pace in the third quarter, the Commerce Department said on Friday.
It would have grown 7.1 percent if businesses had not put the brakes on rising inventories, although economists said that the rise in domestic and foreign demand -- the biggest in more than 26 years -- would be short-lived.
Purchases by U.S. consumers and businesses advanced at a more moderate 3.4 percent rate, a pace unlikely to knock the Federal Reserve off track from efforts to support growth.
The conclusion is the economy appears to be self-sustaining, said Fred Dickson, chief market strategist at The Davidson Cos in Lake Oswego, Oregon.
U.S. stocks were slightly weaker while prices for U.S. government debt rose and the dollar was mixed.
Economists had expected GDP to rise at a 3.5 percent rate in the fourth quarter, but the composition of growth gave the report a robust tenor.
For the whole of 2010, the economy grew 2.9 percent, the biggest gain since 2005. The economy contracted 2.6 percent in 2009.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, grew at a 4.4 percent rate in the final three months of last year -- the fastest pace since the first quarter of 2006. It added 3.04 percentage points to GDP growth, its largest contribution in more than four years.
Consumers are taking note of the improving economic picture. The Thomson Reuters/University of Michigan's consumer sentiment index rose to 74.2 from 72.7 early this month, a separate report showed.
Support to growth during the fourth quarter also came from a pick-up in exports, which resulted in a narrower trade deficit. Trade added 3.44 percentage points to GDP growth, the first contribution in a year, and the biggest since 1980.
World leaders have counted on stronger U.S. exports to help rebalance the global economy. But economists said the sharp contraction in the trade gap was unlikely to last.
The contribution from trade helped offset the drag from business inventories, which increased a mere $7.2 billion after a $121.4 billion rise in the third quarter.
Inventories, which had been the main driver of growth since the start of the recovery in the second half of 2009, subtracted from GDP growth for the first time since the second quarter of that year.
When you have this level of sales without an increase in inventory, there is further room for an increase in production, said Richard DeKaser, an economist at The Parthenon Group in Boston.
EMPLOYMENT STILL LAGGING
Even with growth quickening, progress reducing unemployment has been painfully slow, and the report is little comfort for unemployed Americans or U.S. central bank officials on a jobs-creation vigil.
On Wednesday, Fed officials voiced concern the pace of the recovery was still not strong enough to significantly lower unemployment and reiterated a commitment to a $600 billion stimulus effort through the purchase of government bonds.
The jobless rate has been stuck above 9 percent since May 2009. With the economy's growth potential between 2.5 percent and 2.7 percent, analysts say an expansion rate of at least 3 percent over several quarters is needed to cope with new entrants in the labor market and the unemployed.
The unemployment rate fell to 9.4 percent in December from 9.8 percent in November.
Treasury Secretary Timothy Geithner said on Friday confidence was growing that the economy was heading for a sustainable expansion but the reduction in unemployment would still be tragically moderate.
Business spending on equipment and software notched its seventh straight quarter of growth, though the pace slowed to 5.8 percent from 15.4 percent in the prior quarter.
Although businesses have been hesitant to hire, they have used their vast cash reserves to buy new equipment and upgrade their technology.
Investment in home building and nonresidential structures were surprise additions to growth in the fourth quarter. Home construction grew at a 3.4 percent pace, while structures expanded at a 0.8 percent -- the first growth since the second quarter of 2008.
Government spending contracted, with much of the drag coming from state and local governments.
The advance GDP report also showed a rise in the personal consumption expenditures price index, reflecting the recent surge in food and gasoline prices. The overall PCE price index rose at a 1.8 percent rate after increasing at a 0.8 percent pace in the third quarter.
But the core PCE price index, which excludes food and energy costs, advanced at a record low 0.4 percent pace after rising at a 0.5 percent rate in the previous quarter, highlighting the Fed's concerns about low underlying inflation.
(Editing by Andrea Ricci and Tim Ahmann)