April 27 (Bloomberg) -- The U.S. economy grew last quarter at the slowest pace in four years because of the housing slump and a bigger trade deficit, leaving consumer spending to keep the expansion alive.

The 1.3 percent annual growth rate was less than forecast and followed a 2.5 percent fourth-quarter pace, the Commerce Department reported today in Washington. A measure of inflation watched by the Federal Reserve rose at a faster pace.

Accelerating inflation will probably prevent the Fed from cutting interest rates to spur growth, economists said. This keeps the expansion in the hands of consumers whose confidence has been buffeted by higher fuel prices and the decline in housing. The University of Michigan said today its index of optimism fell this month.

``A lot of the drivers in the economy, with the exception of consumer spending, are slowing and holding back growth,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. ``Given the Fed's focus on inflation right now, they're not in a position to stimulate growth. The Fed is on hold in the near term.''

The dollar fell to a record low against the euro, extending a slide that's being driven by rising interest rates in Europe and faster economic growth than in America. Treasury notes rallied in the minutes after the GDP report was released, before surrendering their gains. The yield on the benchmark 10-year note was unchanged at 4.69 percent at 4:51 p.m. in New York.

First of Three

Today's report is the government's first estimate of the quarter's gross domestic product, the value of all goods and services produced. The figures will be revised in each of the next two months.

Not all economists considered today's report bad news. A gain in business investment and a smaller increase in inventories improve the outlook for this quarter.

``The composition of GDP bodes well for a mild rebound,'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts, and the only analyst to accurately forecast last quarter's growth rate. ``The gain in capital spending is very good news and inventories are a smaller drag. It does look like we are bottoming out. It's fair to say that the first quarter was probably the low point.''

Economists expected a 1.8 percent gain in GDP last quarter, according to the median of 83 forecasts in a Bloomberg News survey. Growth estimates ranged from 1.2 percent to 2.7 percent.

Inflation

The Fed's preferred inflation measure, which is tied to consumer spending and strips out food and energy costs, rose at a 2.2 percent annual rate, up from a 1.8 percent fourth-quarter gain. Fed Chairman Ben S. Bernanke is among policy makers that have said a 1 percent to 2 percent increase is preferable.

Consumer spending, which accounts for about 70 percent of the economy, rose at an annual rate of 3.8 percent last quarter, compared with a 4.2 percent pace in the previous three months. Before today's report, quarterly consumer-spending gains averaged 3.7 percent the past decade.

Home construction fell at an annual rate of 17 percent last quarter, after contracting by 19.8 percent in the previous three months. The decline subtracted 1 percentage point from first- quarter growth. The last time spending on home construction dropped for six consecutive quarters was in 1981-82.

Rebound in Investment

Business fixed investment, which includes spending on commercial construction as well as equipment and software, rose at a 2 percent annual rate, after falling at a 3.1 percent rate from October through December. Spending on new equipment and software increased 1.9 percent.

Economists pared GDP estimates throughout the quarter as Commerce reports showed shipments of capital equipment slumped. Commerce now also uses the Fed's industrial production report, which showed increases in production of computers and communications hardware, to supplement the durable-goods reports in estimating business spending.

Companies added to stockpiles at a $14.8 billion annual rate last quarter after a $22.4 billion annualized fourth- quarter gain. The figures subtracted 0.3 percentage point from growth.

The trade deficit widened to an annual pace of $597.8 billion from $582.6 billion in the fourth quarter. The deficit reduced GDP by 0.52 percentage point.

So far, there is scant evidence of a pickup in growth. The Fed's Beige Book, a compendium of regional anecdotes that will frame policy makers' discussions about the economy when they next meet on May 9, said that most district banks reported ``only modest or moderate'' economic growth since late February. Real estate ``continued to weaken,'' and ``many districts saw a decrease in homebuilding,'' the report said.

Mortgage Defaults

A jump in subprime-mortgage defaults and foreclosures heighten the risk that the real estate slump will linger, economists said. Signs have emerged that woes in manufacturing and housing are suppressing demand in other industries.

Norfolk Southern Corp., the fourth-largest U.S. railroad, said this week that first-quarter profit fell on fewer shipments of autos and homebuilding supplies. Norfolk Chief Executive Officer Charles ``Wick'' Moorman said in an interview that ``we still expect the housing sector and the automotive sector to remain challenges.''

Central bankers have said they expect the economy will improve in the second half of the year as the effects of the housing slowdown dissipate and businesses regain the confidence to resume investing.

``I think the economy is decent,'' General Electric Co. Chief Executive Officer Jeffrey Immelt said before the company's annual shareholder meeting in Greenville, South Carolina, this week. ``I think housing is a tough spot, but the rest of the economy is pretty good.''

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

Last Updated: April 27, 2007 16:54 EDT