Economic growth was revised down to a sluggish 1.6 percent annual rate in the second quarter, pointing to an even softer performance in the third quarter.

The Commerce Department report on Friday showed gross domestic product, the measure of total goods and services output within U.S. borders, was dampened by the largest increase in imports in 26 years. Nonetheless, growth was not quite as weak as anticipated.

So far, analysts do not believe the economy will slide back into recession and say the most likely prospect is for continued soft expansion.

The outlook continues to be one of modest growth rather than double dip. The question remains whether subpar growth that fails to bring down the unemployment rate is a high enough bar for further Fed policy action, said Julia Coronado, an economist at BNP Paribas in New York.

Federal Reserve Chairman Ben Bernanke told monetary policymakers at their annual retreat in Wyoming the recovery had softened more than expected and reiterated the U.S. central bank was ready to take further steps if needed to spur growth.

The committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly, he said.

Gross domestic product growth previously was estimated at 2.4 percent and analysts had feared it would be pushed down even more sharply. But robust business investment and a slight firming in consumer spending partially cushioned the blow.

Financial markets had expected a 1.4 percent growth rate. The economy grew at a 3.7 percent pace in the first quarter.

Economic data for July have so far been downbeat and a Reuters survey forecast third-quarter growth at a 1.7 percent rate, down from expectations of 2.4 percent just over two weeks ago. The chances of a double-dip recession rose to 25 percent from 15 percent.

The better-than-expected second quarter growth figure and Bernanke's to commitment to aid the economy lifted U.S. stocks. Investors, however, dumped U.S. government debt in the biggest sell-off in three months following recent hefty gains. The U.S. dollar rose against the yen.

BAD POLITICAL OMEN

A slackening recovery poses a major political challenge for the Obama administration and the Democratic Party a little over two months away from key mid-term elections that could shift the balance of power in Congress in favor of Republicans.

A Reuters/Ipsos poll this week found Obama's approval rating at 45 percent, overtaken for the first time by a 52 percent disapproval rating.

The White House said four straight quarters of growth were encouraging, adding the administration was focusing on a raft of measures, including helping small businesses and promotion exports. Republicans argue that Obama's policies have failed.

While growth in the United States is slowing, output in other industrialized nations is holding up. Britain's economy grew at its fastest pace in nine years in the second quarter on strong construction activity.

The U.S. economy's recovery from its worst economic downturn since the Great Depression had been largely fueled by an $862 billion government stimulus package and businesses rebuilding inventories from record low levels.

A growing budget deficit makes it unlikely the government will inject more money to shore up the economy.

Growth in the last quarter was stifled by a 32.4 percent surge in imports, the largest since the first quarter of 1984, dwarfing a 9.1 percent rise in exports. That created a trade deficit, which cut 3.37 percentage points from GDP, the largest subtraction since the fourth quarter of 1947.

The growth in imports is across the board. The strong demand for imports indicates there is pent up demand out there, but for growth it's negative because exports are not keeping pace, said Gus Faucher, director of macroeconomics for Moody's Economy.com in West Chester, Pennsylvania.

INVENTORY BOOST FADES

A smaller contribution than initially estimated from business inventories, which had been a major driver of the recovery that started in the second half of 2009, also restrained output.

Business inventories increased $63.2 billion, rather than the previously estimated $75.7 billion, after increasing $44.1 billion in the first three months of the year.

There were some bright spots in the report, with growth in consumer spending revised up to a 2 percent rate from 1.6 percent. Consumer spending grew at a 1.9 percent pace in the first quarter. High unemployment is hurting spending.

A private survey showed consumer sentiment pulled back in late August from earlier in the month but still improved from late July.

Although businesses have held back on hiring, they have been splurging on equipment and software.

Business investment was revised up to a 17.6 percent growth rate, the largest increase since the first quarter of 2006, from the previously estimated 17 percent. Investment in equipment and software was the strongest since the fourth quarter of 1983.

The report also showed corporate profits rose 2.9 percent in the second quarter after increasing 5.8 percent in the first three months of the year.

(Additional reporting by Jeff Mason, Editing by Chizu Nomiyama)