Nov. 29 (Bloomberg) -- The U.S. economy expanded at a revised 2.2 percent annual rate from July through September, faster than forecast, reflecting an increase in inventories that may limit growth this quarter.

The updated figure for gross domestic product, the value of all goods and services produced, compares with a 1.6 percent estimate issued last month, the Commerce Department said today. Incomes and a measure of inflation watched by Federal Reserve policy makers were both revised lower.

A narrower trade deficit and bigger stockpiles helped make up for the biggest drop in home construction in 15 years. The economy may not gain much momentum heading into 2007 as housing remains in a slump and manufacturers trim production to pare stockpiles, economists said.

``The composition of the revision is not all that inspiring,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. ``The upside surprise today is more likely to take away from the fourth quarter than to add to it.''

Bonds were little changed after the report and the dollar pared its advance against the euro. The yield on the benchmark 10-year note fell about 1 basis point to 4.49 percent at 9:55 a.m. in New York.

A separate report from the Commerce Department today showed sales of new homes fell 3.2 percent in October to an annual pace of 1.004 million from a 1.037 million rate in September that was lower than previously reported.

Economist's Forecasts

Economists had forecast a 1.8 percent gain for GDP last quarter, according to the median estimate of 70 estimates in a Bloomberg News survey. Last quarter's growth rate was still the weakest of the year.

Today's growth report is the second of three for the quarter. The Commerce Department will issue its final reading on Dec. 21.

The government's personal consumption expenditures price index, a measure of prices tied to consumer spending, rose 2.4 percent, compared with a 2.5 percent rise reported last month and a 4 percent second-quarter gain.

The index excluding food and energy, a measure favored by Fed policy makers, rose at a 2.2 percent annual rate. The government reported a 2.3 percent third-quarter rise last month, and a second-quarter increase of 2.7 percent.

Fed Chairman Ben S. Bernanke said yesterday that core inflation ``remains uncomfortably high.'' Policy makers are counting on slowing economic growth to reduce inflation. The Fed has left the benchmark overnight lending rate unchanged at 5.25 percent for three consecutive meetings.

Personal Incomes

The government today also revised personal income figures for the second quarter. Wages and salaries rose at an annual rate of 0.7 percent from April through June, down from a previous estimate of 7.7 percent. The measure grew 13.3 percent in the first quarter.

Business inventories rose at a $58 billion annual rate, compared with a $50.7 billion pace of increase previously reported and a $53.7 billion rate of increase in the prior quarter. Inventories added 0.16 percentage points to growth in the third quarter. The government previously estimated that inventories subtracted from economic growth.

``Inventories are too high and there will have to be some sort of correction,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York. ``The fourth quarter is going to look very similar to the third quarter. Housing will be an even bigger negative, the consumer will get a nice little kick from the drop in energy prices.''

Consumer Spending

Consumer spending, which accounts for about 70 percent of the economy, expanded at a 2.9 percent annual pace, compared with 3.1 percent estimated in October and a 2.6 percent pace for the second quarter. The median estimate in a Bloomberg survey of economists was 2.8 percent.

Sales at U.S. retailers in November likely had the smallest gain since March because of disappointing results at Wal-Mart Stores Inc., the International Council of Shopping Centers said this week. Sales accelerated in the final week as shoppers took advantage of discounts the day after Thanksgiving. Holiday sales should still be healthy, ICSC Chief Economist Mike Niemira said.

A narrower trade gap than previously estimated contributed to the revision in the quarter. The gap subtracted 0.21 percentage points from GDP. In the initial estimate, the government reported that trade subtracted 0.58 percentage point from economic growth.

Bernanke yesterday cited housing and auto production as the main hurdles to economic expansion, and said residential construction is likely ``to be a drag on economic growth into next year.''

Residential Construction

Residential construction fell at an 18 percent annual rate in the third quarter, compared with 17.4 percent drop estimated last month and an 11.1 percent decline in the second three months of the year.

D.R. Horton Inc., the largest U.S. homebuilder by revenue, said fiscal fourth-quarter earnings fell 51 percent as customers canceled orders for new houses. The Fort Worth, Texas-based company doesn't expect the market to improve soon.

``As we look forward to 2007 we will have a more challenging year,'' Donald Tomnitz, the company's chief executive, said on a conference call Nov. 14.

Business fixed investment, which includes spending on commercial construction as well as on equipment and software, rose at a 10 percent annual rate last quarter. The government estimated last month that such investment rose at an 8.6 percent pace after a 4.4 percent rate of increase in the second quarter.

Spending on equipment and software rose at a 7.2 percent annual rate, compared with the 6.4 percent previously reported for the quarter.

Investment Outlook

A report yesterday raised concern business investment was slowing this quarter. Orders for durable goods dropped 8.3 percent in October, the most in more than six years, the Commerce Department said.

The drop prompted economists at Credit Suisse Holdings Inc., Morgan Stanley and Bear Stearns Cos. to lower growth economic growth forecasts for this quarter.

Today's report offered the first look at corporate profits for the quarter. Before-tax earnings adjusted for the value of inventories and capital depreciation, known as profits from current production, rose $66.2 billion, or 4.2 percent, compared with a 1.4 percent gain in the second quarter.

To contact the reporter on this story: Joe Richter in Washington at Jrichter1@bloomberg.net

Last Updated: November 29, 2006 10:55 EST