WASHINGTON (Reuters) - U.S. economic growth slowed in the second quarter, the government confirmed on Thursday, but the strongest consumer spending in 4-1/2 years amid a solid labor market threw cold water on financial market expectations of a recession.

FILE PHOTO: Shoppers carry bags of purchased merchandise at the King of Prussia Mall in King of Prussia, Pennsylvania, U.S., December 8, 2018. REUTERS/Mark Makela

Signs that the economy was growing at a moderate pace and not slowing rapidly were underscored by other data showing a narrowing in the goods trade deficit in July as exports rebounded. Businesses stepped up inventory accumulation last month, likely in anticipation that demand would remain strong.

Consumers have so far shown no signs of pulling back, with retail sales powering ahead in July. But there are fears the Trump administration’s year-long trade war with China, which will see additional tariffs on Chinese goods coming into effect in September and December, could take the sails out of consumer spending.

The deterioration in trade relations between the two economic giants has roiled global stock markets and triggered an inversion of the U.S. Treasury yield curve, fanning fears that the longest economic expansion in history was in danger of being interrupted by a recession.

Federal Reserve Chair Jerome Powell said last week that the economy was in a “favorable place,” but reiterated that the U.S. central bank would “act as appropriate” to keep the economic expansion on track.

“The economy is still on cruise control and growing at a slow but steady pace that looks sustainable as the trade wind skies continue to darken,” said Chris Rupkey, chief economist at MUFG in New York.

Gross domestic product increased at a 2.0% annualized rate, the government said in its second reading of second-quarter GDP on Thursday. That was a downward revision from the 2.1% pace estimated last month.

The small downgrade was in line with economists’ expectations. The economy grew at a 3.1% rate in the January-March quarter. It expanded 2.6% in the first half of the year.

The dollar .DXY rose against a basket of currencies, while U.S. Treasury prices fell. Stocks on Wall Street rose, boosted in part by a hopeful tone from China on a resolution of the trade dispute with Washington.

When measured from the income side, the U.S. economy grew at a 2.1% rate in the second quarter. Gross domestic income (GDI) increased at a 3.2% pace in the January-March quarter.

The average of GDP and GDI, also referred to as gross domestic output and considered a better measure of economic activity, rose at a 2.1% rate last quarter, slowing from a 3.2% pace of growth in the first three months of the year.

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The income side of the growth ledger was supported by a rebound in profits after two straight quarterly declines. After-tax profits without inventory valuation and capital consumption adjustment, which correspond to S&P 500 profits, increased at a 4.8% rate after dropping 1.5% in the first quarter.

The economy is largely losing speed as the stimulus from the White House’s $1.5 trillion tax-cut package and a government spending blitz fades. Economists are forecasting growth this year around 2.5%, below the Trump administration’s 3% target.

GOODS TRADE DEFICIT NARROWS

The U.S.-China trade war has weighed heavily on manufacturing and business investment, which contracted in the second quarter.

That is expected to keep the Fed on track to cut interest rates by another quarter-percentage-point cut next month. The Fed lowered its short-term interest rate by 25 basis points last month for the first time since 2008, citing trade tensions and slowing global growth.

But the economy appears to have maintained its moderate pace of growth early in the third quarter. In another report on Thursday, the Commerce Department said the goods trade deficit narrowed 2.5% to $72.3 billion in July as exports rebounded.

Exports of goods rose 0.7% as an acceleration in shipments of motor vehicles, capital and consumer goods offset a plunge in industrial supplies and agricultural exports. The decline in agricultural shipments probably reflects a drop in soybean exports to China.

Goods imports fell 0.4% last month, led by a sharp drop in capital goods. Weak capital goods imports suggests business investment could remain subdued after contracting in the second quarter for the first time since the first quarter of 2016.

The department also reported retail inventories jumped 0.8% in July after falling 0.3% in the prior month. Retail inventories, excluding motor vehicles and parts, the component that goes into the calculation of GDP, rebounded 0.3% last month after dropping 0.2% in June.

“These data suggest any further (growth) slowdown in the third quarter will be modest,” said Paul Ashworth, chief U.S. economist at Capital Economics in Toronto.

Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity, surged at a 4.7% rate in the second quarter. That was the fastest since the fourth quarter of 2014 and was an upward revision from the 4.3% pace estimated last month.

Consumer spending is being driven by the lowest unemployment rate in nearly 50 years. A report from the Labor Department on Thursday showed the number of Americans filing for state unemployment benefits increased slightly last week.

The GDP report showed the trade deficit widened to $982.5 billion in the second quarter instead of $978.7 billion as reported last month. Trade cut 0.72 percentage point from GDP growth last quarter instead of 0.65 percentage point as previously reported.

Growth in inventories was revised down to a $69.0 billion rate in the second quarter from the previously estimated $71.7 billion pace. Inventories chopped 0.91 percentage point from GDP growth last quarter instead of 0.86 percentage point as reported in July. The slowdown in inventory accumulation reflects robust consumer spending.

Business investment declined at an unrevised 0.6% rate in the second quarter. It was pulled down by a 9.4% pace of decline in spending on structures, which reflected drops in commercial and healthcare, and mining exploration, shafts and wells.

Government investment was trimmed as state and local government spending was not as strong as initially thought. Spending on homebuilding contracted for a sixth straight quarter, the longest such stretch since the Great Recession.

(Graphic - Consumer spending contribution to U.S. GDP link: )