WASHINGTON - The U.S. economy grew in the third quarter for the first time in more than a year as government stimulus helped lift consumer spending and home building, fuelling an unexpectedly strong advance.

Signalling the end of the worst recession in 70 years, the Commerce Department on Thursday said the economy expanded at a 3.5 percent annual rate in the July-September period, snapping four down quarters with its fastest growth pace since the third quarter of 2007.

The report, which followed improving third-quarter corporate earnings, lifted stock markets around the world and the broad S&P 500 index of U.S. stocks rose more than half a percentage point at the open. Prices for U.S. government debt and the U.S. dollar fell as traders switched out of safe havens and into riskier assets.

Growth was generally broad-based, with solid gains in consumer spending, exports and home construction. But it was also driven by government programs like the popular cash for clunkers incentive for new auto purchases and an $8,000 tax credit for first-time home buyers.

The auto discount program ended in August and the home tax credit is due to expire next month, although Congress is working on a plan to extend it.

Stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter.

Better than expected GDP is confirming that the Great Recession has ended, said Kevin Flanagan, fixed-income strategist for Global Wealth Management at Morgan Stanley in Purchase, New York. The question going forward is, is this more of a statistical recovery or are we going to get some meaningful momentum on a sustained basis?

Officials from the Federal Reserve -- the U.S. central bank -- meet next Tuesday and Wednesday and will sift through the economic tea leaves to try to determine whether a sustainable recovery is building. They are widely expected, however, to keep stimulative monetary policies in place for some time.

CONSUMERS ARE BACK, FOR NOW
Consumer spending, which normally accounts for more than two-thirds of U.S. economic activity, surged at a 3.4 percent rate in the third quarter, the fastest advance since the first quarter of 2007. Spending had fallen at a 0.9 percent pace in the previous quarter.

Residential investment jumped at a 23.4 percent rate, contributing to GDP for the first time since 2005, after declining 23.3 percent in the April-June period. A housing slump had been the main factor behind the economy's downturn.

A sharp moderation in the pace of inventory liquidation by businesses also supported recovery in the third quarter. Business inventories fell $130.8 billion (78 billion pounds), slowing from the record $160.2 billion plunge in the second quarter. The change added nearly 1 percentage point to the growth in GDP.

Analysts are hoping that the slowdown in the inventory decline by businesses will continue to support the economy in the fourth quarter, even as consumer spending is expected to retreat under the weight of the worst labour market in 26 years. With inventories at a lean level, any advance in consumer spending is more likely to lead to an increase in output.

Excluding inventories, GDP rose at a 2.5 percent rate compared to a 0.7 percent increase in the second quarter.

The weak dollar boosted exports, but a rise in imports subtracted from real GDP during the quarter. Federal government spending contributed to growth, but both state and local governments were a drag.

Business investment fell at a 2.5 percent pace, with spending on nonresidential structures dropping at a 9 percent rate. A lack of credit has hit the U.S. commercial property market hard.

A separate report from the Labour Department showed the number of U.S. workers filing new claims for jobless benefits dipped by 1,000 last week to 530,000. Analysts polled by Reuters had forecast claims to fall to 521,000 from 531,000.

The number of people still on jobless aid after an initial week of benefits slid by 148,000 to 5.8 million in the week ended October 17. It was the lowest reading since March, hinting at some stability in the downtrodden job market.
(Additional reporting by Alister Bull; Editing by James Dalgleish)

New York Morgan Stanley