Jan. 30 (Bloomberg) -- The U.S. economy weakened more than forecast in the fourth quarter as housing sank deeper into recession and consumer spending cooled.

Economic growth slowed to an annual rate of 0.6 percent in October through December, half the rate forecast, following a 4.9 percent pace the previous three months, the Commerce Department said today in Washington. Residential construction dropped by the most in 26 years.

Housing slumped as subprime lending collapsed and financial markets seized up, putting the six-year expansion at risk. The Federal Reserve will likely cut interest rates today for the second time in nine days to shore up business confidence and try to prevent consumer spending from slowing even more.

``The economy is still growing, but it's not growing fast enough,'' said Mark Vitner, senior economist at Wachovia Corp. in Charlotte, North Carolina. ``The Federal Reserve is going to go half a point today.''

Companies in the U.S. added 130,000 workers in January, a private report based on payroll data showed today. The increase in the ADP Employer Services gauge was bigger than economists had forecast, while following a gain of 37,000 in December that was less than half the average monthly increase of the past five years.

Treasury notes were little changed, with the yield on the benchmark 10-year note up 2 basis points to 3.69 percent at 8:44 a.m. in New York. A basis point is 0.01 percentage point. The dollar weakened against the euro.

Economists' Forecasts

The economy was forecast to expand at a 1.2 percent pace, according to the median estimate of 77 economists surveyed by Bloomberg News.

In addition to the slump in housing, the economy was hobbled by a drop in inventories, which may reflect concern over the outlook for consumer spending.

For all of 2007, the economy expanded 2.2 percent, the least in five years, to $11.6 trillion after adjusting for inflation.

Price increases accelerated last quarter as fuel costs climbed. The report's price index rose at a 2.6 percent annual pace, up from 1 percent in the previous three months.

The Fed's preferred inflation gauge, which is tied to consumer spending and strips out food and energy costs, rose at a 2.7 percent pace. The increase was the biggest since the second quarter of 2006.

Housing Bust

Home construction plunged 24 percent last quarter, the eighth consecutive drop and the biggest since the last three months of 1981. That subtracted 1.2 percentage points from growth. Residential construction is now down 29 percent over the last two years, making it the biggest housing slump since 1982.

Consumer spending, which accounts for more than two-thirds of the economy, grew at a less-than-forecast 2 percent pace from October to December and contributed 1.4 percentage points to growth. Spending increased 2.9 percent for all of 2007, the least in four years.

The economy may not be able to count on continued gains in spending in coming months as property values slump and the unemployment rate rises, economists said.

Business spending also cooled, growing at a 7.5 percent pace last quarter, compared with 9.3 percent in the previous three months. Spending on commercial construction projects was little changed, while purchases of equipment and software softened.

Stockpiles Fall

An unexpected drop in inventories, led by declining stockpiles at automakers, was one of the major reasons the economy grew less than forecast last quarter. Stockpiles fell at a $3.4 billion annual rate, the biggest decline in almost six years, subtracting 1.3 percentage points from growth.

Excluding a 27 percent slump in auto production, the economy grew at a 1.6 percent pace.

A narrower trade deficit provided a boost to the economy. The gap shrank to $521 billion at an annual pace from $533.1 the previous three months. For all of 2007, trade contributed 0.55 percentage point to growth, the most since 1991.

Still, the fallout from housing is filtering through the economy. Trane Inc., a maker of air conditioners, yesterday said fourth-quarter profit fell 16 percent from a year earlier. The Piscataway, New Jersey-based company forecast sales may decline in its residential business.

``There's no question we will feel the pain in 2007, 2008 and possibly into 2009,'' Chief Financial Officer Peter D'Aloia said on a conference call with analysts.

Fed May Cut

The Fed may lower the benchmark interest rate by a half point to 3 percent today to ward off a broader downturn, according to economists surveyed. Central bankers cut the rate by three-quarters of a percentage point on Jan. 22, the largest reduction in the two decades that it has been the principal tool of policy makers.

Harvard University economist Martin Feldstein, a member of the group that dates U.S. economic cycles, has said a recession this year may be deeper than recent ones.

``If we have it, it will be very difficult and could be much more painful because of the fragility of the financial sector,'' Feldstein, president of the National Bureau of Economic Research, said in a Jan. 28 Bloomberg Radio interview. Feldstein earlier this year estimated a greater than 50 percent chance of recession.

The report on gross domestic product is the first for the quarter and will be revised in February and March as more information becomes available.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

Last Updated: January 30, 2008 08:48 EST