Oct. 29 (Bloomberg) -- The U.S. economy returned to growth in the third quarter after a yearlong contraction as government incentives spurred consumers to spend more on homes and cars.

The world’s largest economy expanded at a 3.5 percent pace from July through September, figures from the Commerce Department showed today in Washington. Household purchases climbed 3.4 percent, the most in two years.

Policy makers will now focus on whether the recovery, supported by government spending and tax credits, can be sustained into 2010 and generate jobs. The record $1.4 trillion budget deficit means President Barack Obama has little room for maneuver as he tries to keep unemployment from rising above 10 percent, while Federal Reserve policy makers wind down emergency programs in a bid to prevent a surge in inflation.

“Consumers will feel that the news is getting better, but not good,” Joel Naroff, president of Naroff Economic Advisors Inc. in Holland, Pennsylvania, and the top economic forecaster last year according to a survey by Bloomberg Markets magazine, said in an interview. Americans “are not going to see businesses out there hiring a whole lot of people and the unemployment rate is likely to continue to rise.”

Stocks jumped and Treasuries declined after the report. The Standard & Poor’s 500 Index was up 2.3 percent, the most since July 23, to 1,066.11 at 4:05 p.m. in New York. The yield on the 10-year Treasury note rose eight basis points to 3.49 percent. A basis point is 0.01 percentage point.

Jobless Claims

A report from the Labor Department showed 530,000 workers filed claims for jobless benefits last week, more than anticipated and signaling the job market is slow to heal even as growth picks up.

Obama said that while today’s report shows the recession is abating, the nation has “a long way to go” to fully recover and bring down unemployment.

“The benchmark I use to measure the strength of our economy is not just whether our GDP is growing, but whether we’re creating jobs, whether families are having an easier time paying their bills, whether our businesses are hiring and doing well,” he told business leaders on the White House grounds.

The economy was forecast to grow at a 3.2 percent annual pace, the median estimate of 79 economists surveyed by Bloomberg News. Projections ranged from gains of 2 percent to 4.8 percent.

The 3.8 percent contraction in the 12 months to June was the worst performance in seven decades. The four consecutive decreases mark the longest stretch of declines since quarterly records began in 1947.

‘Cars-for-Clunkers’

Growth in consumer spending, which accounts for about 70 percent of the economy, “largely reflected” an increase in purchases of automobiles attributable to the government’s “cash-for-clunkers” plan, the report said.

Purchases of durable goods, which include autos, jumped 22 percent, the biggest increase since 2001. Excluding sales, production and inventories of automobiles, the economy grew 1.9 percent last quarter.

While most economists estimate the recession has ended, the National Bureau of Economic Research, based in Cambridge, Massachusetts, is responsible for determining when contractions begin and end. Robert Hall, head of the committee charged with making the call, said in August it may take more than a year for the group to reach a conclusion.

Residential construction jumped at a 23 percent annual rate last quarter, the first gain in almost four years and the biggest since 1986. The rebound added 0.5 percentage point to growth.

Homebuilding Jumps

Homebuilding surged as sales climbed, propelled in part by an $8,000 tax credit for first-time buyers. The credit would be extended and some people who already own residences could claim a benefit under an agreement reached yesterday by Senate Democrats.

Fed purchases of mortgage-backed securities have also helped spur home sales by lowering borrowing costs. The central bank plans to buy $1.25 trillion of the securities through the end of March.

Policy makers led by Fed Chairman Ben S. Bernanke next meet Nov. 3-4 and are likely to repeat their promise to keep interest rates very low for an “extended period.”

An improving global economy helped companies from Amazon.com Inc. to Whirlpool Corp. exceed analysts’ sales estimates last quarter. Profits at about 85 percent of the companies in the Standard & Poor’s 500 Index that have released results beat expectations, according to Bloomberg data. That marks the highest proportion in records going back to 1993.

Global Recovery

“You should see more expansion in the categories we’re in, as well as more geographical expansion over time,” Chief Financial Officer Thomas Szkutak of Amazon.com, the world’s largest Internet retailer, said on an Oct. 22 conference call.

Total inventories last quarter continued to drop, boosting expectations that factory production will keep growing. The drop in stockpiles was smaller than the record decrease in the second quarter, contributing to growth, today’s report showed.

Lean stockpiles are the main reason the economy will continue to grow in coming quarters at about the same pace as in the past three months as companies boost production, said Naroff. The gain in output will not lead to a quick rebound in hiring, he said.

In September, the unemployment rate reached a 26-year high of 9.8 percent, up from 7.6 percent from when Obama took office in January, figures from the Labor Department show. Economists project the jobless rate will exceed 10 percent by early 2010.

Since the recession began in December 2007, the U.S. has lost 7.2 million jobs. Payroll cuts peaked at 741,000 in January before falling to 263,000 job losses in September.

The economy will likely grow at a 2.4 percent annual rate from October through December, the median forecast in a survey earlier this month showed. GDP will also grow 2.4 percent next year and 2.8 percent in 2011, the survey showed, compared with an average of 3.4 percent growth over the past six decades.

To contact the reporter on this story: Timothy R. Homan in Washington at thoman1@bloomberg.net

Last Updated: October 29, 2009 16:55 EDT