U.S. economic growth unexpectedly accelerated in the second quarter, laying a firmer foundation for the rest of the year that could bring the Federal Reserve a step closer to cutting back its monetary stimulus.
Gross domestic product grew at a 1.7 percent annual rate, the Commerce Department said on Wednesday, stepping up from the first-quarter's downwardly revised 1.1 percent expansion pace.
Economists polled by Reuters had forecast the economy growing at a 1.0 percent pace after a previously reported 1.8 percent advance in the first three months of the year.
A separate report showed private employers maintained a higher pace of hiring in July, adding to the brightening economic picture.
"We have an upside surprise in the GDP which speaks volumes for the job recovery that we're putting together. The recovery in the economy is starting to take root," said Andre Bakhos, director of market analytics at Lek Securities in New York.
U.S. Treasury debt prices fell on the data, while the dollar rallied against the yen and advanced against the euro. U.S. stock index futures were little changed.
A rebound in business spending, export growth and a sharp moderation in the pace of decline in government outlays boosted economic growth in the April-June period, offsetting a slowdown in consumer spending and a steady rate of inventory accumulation.
Still, the report marked a third straight quarter of GDP growth below 2 percent, a pace that normally would be too soft to bring down unemployment. But growth was poised to gain even more momentum in the second half of the year as the fiscal burden brought on by belt-tightening in Washington eases.
Federal Reserve officials, wrestling with a decision on the future of their $85 billion per month bond-buying program, will draw comfort from the pick-up in output last quarter. They wind up a two-day meeting later on Wednesday.
Fed Chairman Ben Bernanke said last month that the central bank was likely to start curtailing the bond purchases later this year and would probably bring them to a complete halt by the middle of 2014, if the economy progressed as expected.
"The Fed's view is that the fiscal headwinds will dissipate in the coming months," said Thomas Costerg, U.S. economist at Standard Chartered in New York. "If you discount the fiscal drag, growth would be stronger, and I think that's what the Fed is looking at."
SILVER LINING IN REVISIONS
Adding to the better tenor of the report, comprehensive revisions to the data cast the economy in a better light than previously.
The government has implemented some changes in how it calculates GDP. For example, research and development spending will now be treated as investment, and defined benefit pension plans will be measured on an accrual basis, rather than as cash.
Economic growth was relatively stronger between 2009 and 2012 than previously reported. In fact, the economy grew 2.8 percent last year, 0.6 percentage point faster than the government had previously estimated.
The revisions also yielded a higher rate of savings, a good omen for consumer spending in the future.
Higher taxes, as Washington tries to shrink the government's budget deficit, constrained consumer spending in the second quarter, keeping the economy on an anemic growth pace.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, slowed to a 1.8 percent growth pace after rising at a 2.3 percent rate in the first quarter.
The slow pace of consumption kept a lid on inflation pressures, with the personal consumption expenditures price index unchanged in the second quarter. Excluding food and energy, prices rose 0.8 percent. Both measures were the weakest since the first quarter of 2009.
But higher savings and a firming labor market should help to spur consumer spending. Businesses added 200,000 jobs to their payrolls in July, the ADP National Employment Report showed, after hiring 198,000 workers in June.
Tepid domestic demand saw businesses keeping their inventories from bulging in the second quarter. Inventory accumulation added 0.41 percentage point to growth, less than half its contribution in the prior quarter.
Other details of the report showed exports rebounded, showing the largest percentage gain since the third quarter of 2011, even as demand weakened in Europe and China. But the increase was not enough to offset a rise in imports, leaving a trade deficit that weighed on growth.
There was good news from the housing sector, with double-digit growth for spending on residential construction. Housing, which triggered the 2007-09 recession, is growing strongly, helping to keep the economic recovery anchored.
However, a rise in mortgage rates on the back of growing expectations of a reduction in the Fed's bond purchases has cooled the appetite of some potential buyers.
The Mortgage Bankers Association said on Wednesday that its index of mortgage application activity fell for the seventh week in a row last week.
Business spending on equipment and software reversed the prior quarter's decline, lifted by a turnaround in investment in nonresidential structures and gains in outlays on equipment and intellectual products.
While government spending contracted for a third straight quarter, the pace of the decline slowed sharply as state and local government spending rebounded. Defense spending fell marginally after declining sharply in the past two quarters.
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