Inventories Seen Weighing on U.S. 3Q Growth

U.S. economic growth likely braked sharply in the third quarter as businesses cut back on restocking warehouses to work off an inventory glut, but solid domestic demand could encourage the Federal Reserve to raise interest rates in December.

Gross domestic product probably increased at a 1.6 percent annual rate after expanding at a 3.9 percent clip in the second quarter, according to a Reuters survey of economists. But GDP could print slightly higher after data on Wednesday showed a smaller-than-expected goods trade deficit in September.

The Commerce Department will release its snapshot of third-quarter GDP on Thursday at 08:30 a.m. (1230 GMT).

Given that the inventory drag is probably temporary, economists urged caution against reading too much into the growth deceleration.

"It's not going to look pretty, but I don't think the policy implications from the Fed's perspective are overly significant. They are going to look through the weakness in GDP because of the weight from inventories," said Ryan Sweet, a senior economist at Moody's Analytics in Westchester, Pennsylvania.

The Fed on Wednesday described the economy as expanding at a "moderate" pace and put a December rate hike on the table with a direct reference to its next policy meeting. The U.S. central bank has kept benchmark overnight interest rates near zero since December 2008.

The economy has struggled to sustain a faster pace of growth since the end of the 2007-2009 recession, with average yearly growth failing to break above 2.5 percent.

In the third quarter, businesses are forecast to have accumulated between $41 billion and $57 billion worth of inventory, down sharply from $113.5 billion in the second quarter. Economists estimate the small inventory build will slice off at least 1.5 percentage points from third-quarter GDP growth.

Trade was seen as another impediment to growth, although a small one, given the strong dollar's dampening impact on exports and stimulative effect on imports. Trade is forecast to subtract at least one-tenth of a percentage point from GDP growth.

CONSUMERS TO THE RESCUE

But the blow from inventories and trade was likely blunted by bullish consumers, who are getting a tailwind from cheaper gasoline, and firming housing and labor markets.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, is forecast growing at around a 3.4 percent rate after a expanding at a 3.6 percent pace in the second quarter. A measure of private domestic demand, which excludes trade, inventories and government spending, is forecast to have risen at a sturdy pace.

"The economy kept its strong underlying momentum throughout the summer. This implies that the weakness in the third quarter will prove to be a temporary breather and that growth will again be perceptively stronger in the current quarter," said Harm Bandholz, chief U.S. economist at UniCredit Research in New York.

Ongoing spending cuts in the energy sector are also expected to have undermined growth. A plunge in oil prices has prompted oil field companies like Schlumberger and Halliburton to slash investment.

Schlumberger said this month it did not expect a recovery in demand before 2017 and anticipated that exploration and production spending would fall again in 2016.

Despite strong domestic demand, inflation likely remained muted because of dollar strength and cheaper gasoline. A price index in the report that strips out food and energy costs is expected to have increased at a 1.4 percent rate, slowing from a 1.9 percent pace in the second quarter.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)