FILE PHOTO: A woman carries shopping bags in Manhattan in New York City, U.S., August 11, 2025. REUTERS/Eduardo Munoz/File Photo

By Lucia Mutikani

WASHINGTON (Reuters) -The U.S. economy grew faster than previously estimated in the second quarter amid strong consumer spending and business investment, though momentum appears to be slowing as the effects of tariffs and policy uncertainty start to filter through.

The quickest growth pace in nearly two years reported by the Commerce Department on Thursday also reflected a sharp contraction in the trade deficit as the flood of imports slowed.

The economy's resilience was underscored by other data showing strong demand by business for equipment in August, driven by an artificial intelligence (AI) spending boom, and a drop in first-time applications for state unemployment benefits last week as companies hoard workers.

The data at face value suggested further interest rate cuts from the Federal Reserve were probably unwarranted. Tepid hiring blamed by economists on President Donald Trump's import duties and an immigration crackdown caused job growth to almost stall in the three months through August, prompting the U.S. central bank to resume its policy easing last week.

"It is clear that the current level of Fed interest rates is not slowing the economy down and is not hurting the labor market either," said Christopher Rupkey, chief economist at FWDBONDS. "If job growth is slowing down, it is not the economy that is the problem, it is the Trump 2.0 policies on immigration."

Gross domestic product increased at an upwardly revised 3.8% annualized rate last quarter, the fastest pace since the third quarter of 2023, the Commerce Department's Bureau of Economic Analysis said in its third GDP estimate.

The economy was previously reported to have grown at a 3.3% pace in the second quarter. Economists polled by Reuters had expected GDP growth would be unrevised.

The government revised the national accounts data from the first quarter of 2020 through the first quarter of 2025. The economy contracted at a 0.6% pace in the first quarter, revised slightly down from the previously reported 0.5% pace of decline.

Growth estimates for the first and fourth quarters of 2024 were revised significantly lower, but were offset by upgrades to second- and third-quarter GDP. The economy grew 2.8% in 2024, unrevised from the previous estimate.

A sharp narrowing of the trade deficit as imports collapsed after a record surge in the January-March quarter was the main driver of the rebound in GDP last quarter. The smaller trade deficit added a record 4.83 percentage points to GDP growth after slicing off 4.68 percentage points in the first quarter.

Imports surged in the January-March quarter as businesses rushed to beat the duties, which boosted the nation's average tariff rate to its highest level in a century. Both the first- and second-quarter GDP readings are not a true reflection of the economy's health because of the wild swings in imports.

Trade could add to GDP growth in the third quarter. A separate report from the Commerce Department's Census Bureau showed the goods trade deficit contracted 16.8% to $85.5 billion in August as imports plunged.

The upgrade to second-quarter GDP mostly reflected an upward revision to consumer spending, which is now estimated to have increased at a 2.5% pace, instead of the previously reported 1.6% rate. There was increased spending on services like transportation as well as finance and insurance.

Consumer spending, the main engine of the economy, grew at a 0.6% rate in the first quarter, revised up from a 0.5% pace.

Business spending on intellectual property products was upgraded to a 15.0% rate from the 12.8% pace estimated last month. Business investment in equipment grew at a faster 8.5% clip instead of the previously reported 7.4% pace.

Business spending on equipment is so far holding up in the third quarter, though the pace of growth has probably slowed.

A third report from the Census Bureau showed non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, rose 0.6% in August after advancing 0.8% in July. Shipments of these so-called core capital goods slipped 0.3% after rising 0.6% in July.

Stocks on Wall Street fell as investors viewed the data as not supportive of further rate cuts. The dollar rose against a basket of currencies. U.S. Treasury yields were higher.

SLOW GROWTH IS EXPECTED IN THE SECOND HALF

Last week's 25 basis point cut lowered the Fed's benchmark overnight interest rate to the 4.00%-4.25% range. There were small upward revisions to inflation last quarter.

Inflation has been slow to rise in response to tariffs as businesses sold inventory accumulated before the duties kicked in and even absorbed some of the taxes. Inventory accumulation decreased at a $18.3 billion rate in the second quarter.

Final sales to private domestic purchasers, which exclude trade, inventories and government, and are viewed by economists and policymakers alike as a barometer of underlying economic growth, grew at a 2.9% rate in the second quarter. That was an upward revision to the previously reported 1.9% pace.

Economists are bracing for lackluster growth in the second half of the year because of the lingering drag from trade policy uncertainty as well as mass deportations, which are hampering job growth through reduced labor supply.

"Notwithstanding an expected moderate real GDP gain in the third quarter - driven by resilient consumer spending, the AI investment boom and wild swings in international trade - growth is projected to decelerate in the second half of the year," said Lydia Boussour, senior economist at EY-Parthenon.

Growth estimates for the third quarter are converging around a 2.5% rate.

There were notable downward revisions to profit estimates last quarter, suggesting businesses were not dumping all tariffs on consumers. Economists warned a compression of profit margins could pressure the labor market.

A fourth report from the Labor Department showed initial claims for state unemployment benefits dropped 14,000 to a seasonally adjusted 218,000 for the week ended September 20.

"The hit to corporate profit margins has been small, which is key," said Ryan Sweet, chief U.S. economist at Oxford Economics. "If corporate profit margins compress it would increase the odds of a significant increase in layoffs."

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)