WASHINGTON (Reuters) - U.S. economic growth slowed sharply in the fourth quarter as weak business spending and a wider trade deficit offset the fastest pace of consumer spending since 2006.
The slowdown followed two back-to-back quarters of bullish growth and is likely to be short-lived given the enormous tailwind from lower gasoline prices. Other data on Friday showed consumer sentiment jumped to an 11-year high in January.
"We look for strong domestic consumption to continue supporting growth momentum in the coming quarters even as investment suffers due to falling oil prices," said Gennadiy Goldberg, an economist at TD Securities in New York.
Gross domestic product expanded at a 2.6 percent annual pace after the third quarter's 5 percent rate, the Commerce Department said in its first snapshot of fourth-quarter GDP.
A gauge of underlying demand, which excludes trade, inventories and government, increased at a 3.9 percent pace. That compared to the third quarter's 4.1 percent rate. Analysts said the data indicated domestic fundamentals were strong enough to cushion the blow on growth from weakening overseas economies.
"The strength of domestic demand will more than offset the headwinds from abroad, including a slower pace of export growth as a result of the strengthening U.S. dollar," said Sam Bullard, a senior economist at Wells Fargo.
"Sharply lower oil prices do present downside risk to business investment, but accruing benefits to the consumer in the form of lower gasoline prices should increasingly offset the near-term drag."
First-quarter growth estimates are currently converging around a 2.5 percent pace, with an acceleration anticipated for the rest of 2015. Economists had expected GDP to expand at a 3 percent rate in the fourth quarter.
U.S. stocks fell, while prices for U.S. Treasury debt rose, with the yield on the 30-year bond hitting a record low. The dollar was unchanged against a basket of currencies.
For all of 2014, the economy grew 2.4 percent compared to 2.2 percent in 2013. The report came two days after the Federal Reserve said the economy was growing at a "solid pace," an upgraded assessment that keeps it on track to start raising interest rates this year.
The U.S. central bank has kept its short-term interest rate near zero since December 2008.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, advanced at a 4.3 percent pace in the fourth quarter - the fastest since the first quarter of 2006 and an acceleration from the third quarter's 3.2 percent pace.
Lower gasoline prices - they are down 43 percent since June, according to government data - and a strengthening labor market are fueling a surge in optimism among households. The University of Michigan's consumer sentiment rose to 98.1 this month, the best reading since January 2004, from 93.6 in December.
"The level of consumer sentiment supports our view that consumer spending will kick the year off on a robust foot after the drop in energy prices left consumers' wallets full," said Bricklin Dwyer, an economist at BNP Paribas in New York. A separate report from the Labor Department showed wages rising steadily in the fourth quarter, but still below levels that would bring inflation closer to the Fed's 2 percent target.
Inflation pressures were muted in the fourth quarter, with the personal consumption expenditures price index falling at a 0.5 percent rate, the weakest reading since the first quarter of 2009. Excluding food and energy, prices rose at a 1.1 percent pace, the slowest since the second quarter of 2013.
"With inflation likely remaining sluggish in 2015, a patient Fed will likely wait until September to begin a slow and steady tightening cycle," said Michelle Meyer, a senior economist at Bank of America Merrill Lynch in New York.
The strong pace of consumer spending in the fourth quarter, however, was overshadowed by a drop in capital expenditure. Business spending on equipment fell at a 1.9 percent rate. It was the largest contraction since the second quarter of 2009.
Business spending on equipment had advanced at an 11 percent rate in the third quarter. The fourth-quarter weakness could reflect cuts or delays to investment projects in the oil industry. But it could also be payback after two back-to-back quarters of robust gains.
A fourth report showing factory activity in the Midwest increased in January, after two straight months of declines, suggests that a rebound in business spending is in the cards.
A wider trade deficit, as slower global growth curbed exports and solid domestic demand sucked in imports, subtracted 1.02 percentage point from GDP growth in the fourth quarter. Trade had added 0.78 percentage point to third-quarter growth.
Restocking by businesses contributed 0.82 percentage point to fourth-quarter GDP. Government spending was a drag as a defense-driven investment burst faded, while residential construction made a mild contribution to GDP growth.
Reporting by Lucia Mutikani; Additional reporting by Ryan Vlastelica in New York; Editing by Paul Simao