Oct. 27 (Bloomberg) -- The U.S. economy grew at a 1.6 percent annual rate last quarter, the slowest pace in more than three years and less than economists forecast, as housing slumped and the trade deficit widened.

The first estimate of the quarter's gross domestic product, the value of all goods and services produced in the U.S., compares with a 2.6 percent gain from April through June, the Commerce Department reported today in Washington. A gauge of inflation watched by the Federal Reserve eased.

Stocks declined and bonds advanced after the report, which showed homebuilding fell by the most in 15 years and the trade gap worsened as consumers bought more foreign-made goods. A drop in energy prices that gathered momentum late in the quarter is sustaining spending and restraining inflation, helping persuade Fed Chairman Ben S. Bernanke to leave interest rates alone.

``The Fed is going to be pleased with the fact that their tightening efforts are bearing fruit with slower growth,'' said Richard DeKaser, chief economist at National City Corp. in Cleveland. ``It's not yet providing the comfort level on inflation that the Fed would like to see, but it's on the right track.''

The figure fell short of the 2 percent median forecast of economists polled by Bloomberg News. Estimates of growth ranged from 1 percent to 3 percent.

In a sign of optimism for the current quarter, consumer confidence climbed to a 15-month high in October, the University of Michigan reported today. The university's sentiment index rose to 93.6, exceeding forecasts, up from 85.4 in September.

Auto Anomaly

The number is subject to two revisions by the Commerce Department. The report showed auto production rose at an annual rate of 26 percent last quarter, astonishing many economists who had projected a drop after General Motors Corp., Ford Motor Co. and others announced reductions.

The anomaly may be explained by looking at how the government adjusts the figures for price changes, said Joe Carson, director of economic research at AllianceBernstein LP in New York. A drop in the wholesale price of SUVs and light trucks as the automakers cleared leftover 2006 models made production look stronger than it was and the economic fallout from auto- industry cutbacks will instead come this quarter, Carson said.

Risk for Republicans

The slowing economy may make it harder for Republicans, struggling to retain control of Congress, to tout growth as a product of President George W. Bush's $2 trillion in tax cuts. Treasury Secretary Henry Paulson said in an interview today that the economy is ``healthy,'' citing consumer spending and investment by companies.

``I feel very good about this economy,'' Paulson told reporters at the Treasury in Washington. ``You are going to get quarters when it's below trend and above trend.''

Residential housing construction fell at an annual rate of 17.4 percent last quarter, the biggest decline since the first quarter of 1991, after shrinking at an 11.1 percent pace in the previous three months. The decline, partly a result of the Fed's two-year run of interest-rate increases through June, subtracted 1.12 percentage points from growth, the most in almost a quarter century.

`Ill Wind'

``We are feeling the effects of the housing bubble bursting and, while the ill wind is not pleasant, it is not likely to be long lasting,'' said Joel Naroff, president of Naroff Economic Advisors in Holland, Pennsylvania. ``Businesses and households did their part to keep the economy going.''

The trade deficit widened to $639.9 billion last quarter from $624.2 billion. The shortfall subtracted 0.58 percentage point from GDP.

Also hampering the expansion, companies added to stockpiles at an annual rate of $50.7 billion last quarter after adding to inventories at a $53.7 billion pace in the second three months of the year. The figures subtracted 0.1 percentage point.

There's evidence the slowdown in the economy was temporary.

Consumer spending, which accounts for about 70 percent of the economy, rose at an annual rate of 3.1 percent last quarter, compared with a 2.6 percent pace in the previous three months. Rising incomes and cheaper fuel helped consumers weather the effects of falling home values, economists said.

The price of unleaded gasoline this month has averaged $2.25 a gallon, down from $2.84 a gallon average in the second quarter and more than $3 in July.

Investment Picks Up

Business fixed investment, which includes spending on commercial construction as well as equipment and software, rose at an 8.6 percent annual rate in the third quarter, after rising at a 4.4 percent rate from April through June. Spending on new equipment and software rose 6.4 percent.

Fed policy makers held their benchmark lending rate at 5.25 percent for a third straight meeting this week and predicted a ``moderate'' pace of expansion.

``I suspect the Fed is very pleased'' with the slowdown shown in today's report, said John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina. ``It gives them more time to be patient. Inflation is topping out and is likely to come down over the next two to three quarters, and that is consistent with the Fed keeping its current position.''

Inflation Measure

The government's personal consumption expenditures price index, a measure of prices tied to consumer spending, rose 2.5 percent after a 4 percent rise in the second quarter. The index excluding food and energy, a measure favored by Fed policy makers, rose at a 2.3 percent annual rate after increasing at a 2.7 percent pace.

The GDP price index, a measure of prices tied to the report rose at a 1.8 percent annual rate in the second quarter, following a 3.3 percent second-quarter gain.

Norfolk Southern Corp., the fourth-largest U.S. railroad, boosted freight rates, helping third-quarter profit increase 38 percent. Sales rose 11 percent.

``Overall, we don't see any drastic slowing of the entire economy,'' Norfolk Southern Chief Executive Officer Charles ``Wick'' Moorman said in an interview. ``We think that pricing power will stay with us for a while.''

The value of all goods and services produced in the U.S. economy, the world's largest, rose to an annual rate of $11.4 trillion after adjusting for inflation. Unadjusted for price changes, GDP rose at a 3.4 percent annual pace to $13.3 trillion. Government spending rose at a 2 percent annual rate.

Ford Motor Co., the second-biggest U.S. automaker, said car and light truck sales dropped 17 percent during the quarter. The Dearborn, Michigan-based company cut third-quarter production by 11 percent, and plans to slash output by 21 percent this quarter.

Peoria, Illinois-based Caterpillar Inc., the world's biggest maker of earthmoving equipment, said last week that dealers started cutting back inventory in the third quarter. Sales of construction equipment such as bulldozers will be less than the company anticipated as home construction slows down, and the company said it expects a ``sharp drop'' in sales of truck engines.

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

Last Updated: October 27, 2006 15:13 EDT