Dec. 12 (Bloomberg) -- The U.S. trade deficit shrank by the most in almost five years in October as the price of imported oil dropped and faster growth abroad propelled exports to a record.

The Commerce Department said today in Washington that the gap narrowed 8.4 percent to $58.9 billion, less than forecast by economists. The improvement came even as the U.S. had a record shortfall with China, which is on course to surpass Mexico this year as the nation's second-biggest trading partner behind Canada.

A weaker dollar and demand from Europe and Asia may spur exports and limit weakness in manufacturing, keeping the economy expanding as housing slumps. At the same time, the widening deficit with China is aggravating tensions between the two nations, friction that Treasury Secretary Henry Paulson is seeking to ease in meetings in Beijing this week.

``We're seeing slow but steady growth in exports, and I expect to see that continue,'' said Chris Low, chief economist at FTN Financial in New York. ``The big standout in the report was the new peak in the deficit with China. It may be time for Paulson to turn up the volume in pressuring China.''

Shipments to Germany, Japan, Central America, South America and members of the Organization of Petroleum Exporting Countries climbed to a record. On a year-to-date basis, China vaulted over Mexico to become the second-biggest trading partner of U.S.

Economists expected the trade deficit to narrow to $63 billion, from September's $64.3 billion, according to the median of 62 forecasts in a Bloomberg News survey. October's gap was the smallest since August 2005.

Fed Meeting

Treasury securities rose after the Federal Reserve left interest rates unchanged for a fourth straight meeting. The benchmark 10-year note gained 1/4 point, pushing down the yield 3 basis points to 4.49 percent at 2:42 p.m. in New York.

``Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market,'' Fed policy makers said in a statement announcing their decision to keep the overnight lending rate between banks at 5.25 percent. ``Although recent indicators have been mixed, the economy seems likely to expand at a moderate pace on balance over coming quarters.''

The dollar fell after strengthening in the minutes after the trade report was released. The dollar lost 0.8 percent against a basket of currencies in October and weakened 2.8 percent in November, according to the New York Board of Trade's Dollar Index. It's down 7.4 percent this year.

Imports Decline

Imports of goods and services dropped 2.7 percent in October, the most since December 2001, to $182.5 billion. The deficit in petroleum products dropped by $3.9 billion to $18.8 billion, the smallest since June last year. The average price per barrel of imported crude oil fell to $55.47, the lowest since March, from $62.52.

Consumer goods imports rose $238 million to $38.3 billion, reflecting demand for medicines, toys and stereo equipment.

Exports rose 0.2 percent to $123.6 billion. The gain reflected increasing demand for computers, drilling equipment and medicines.

``We have strong growth abroad and that is good for exports,'' said Elisabeth Denison, an economist at Dresdner Kleinwort in New York. ``That should lead to a stabilization'' in the trade deficit next year, she said.

China Role

The trade deficit with China rose to $24.4 billion, from $23 billion in September. Imports from China rose to $29.3 billion in October. U.S. exports to the country rose to $4.9 billion from $4.6 billion. Year to date, total trade with China reached $281 billion, passing Mexico's $278.3 billion.

Paulson, Fed Chairman Ben S. Bernanke and Commerce Secretary Carlos Gutierrez are among a group of U.S. officials going to China this week in what will become an ongoing effort to address differences. The U.S. is China's biggest trading partner.

U.S. congressional leaders and manufacturers have criticized China for keeping its currency, the yuan, undervalued in order to promote sales overseas. They've also said the country has failed to crack down on rampant piracy and has kept some industries closed to overseas competition.

White House chief economic adviser Allan Hubbard said in an interview on Dec. 8 that President George W. Bush's administration is ``very frustrated'' with the pace of China's shift toward a market-based exchange rate.

European Growth

A brightening economic picture in Europe is helping spur exports. The European Central Bank last week raised its euro- region growth forecast to about 2.2 percent next year and 2.7 percent in 2006.

Europe's economy probably continued to expand at a ``robust'' pace in the current quarter after growing 0.5 percent in the previous three months, ECB President Jean-Claude Trichet said at a press conference in Frankfurt last week after the bank raised its key rate for a sixth time this year.

The Organization for Economic Cooperation and Development said on Dec. 8 that the world economy will continue to expand next year. The OECD's leading economic indicator rose to 109.7 in October, from 109.5 the previous month. The measure for Japan rose 0.2 and that for China increased 2.6. Other regions showing gains included Canada and Europe.

Caterpillar Outlook

``I think we'll have a reasonably strong global economy next year, just a weak U.S. economy,'' James Owens, chief executive officer of Caterpillar Inc., the world's largest maker of earth-moving equipment, said at a manufacturing conference on Dec. 7. ``A lot of the major markets we serve -- oil and gas, mining --on a global scale are doing very well.''

Slower U.S. growth and a buildup in inventories in the third quarter may continue to limit imports, said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York. The bigger-than-expected drop in the deficit may cause economists to raise their projections for gross domestic product this quarter.

The U.S. economy will expand at a 2 percent rate during the last three months of this year, according to the median forecast of economists surveyed by Bloomberg from Dec. 1 to Dec. 8. Last month, economists expected growth of 2.5 percent.

To contact the reporters on this story: Courtney Schlisserman in Washington at cschlisserma@bloomberg.net

Last Updated: December 12, 2006 14:52 EST