Feb. 25 (Bloomberg) -- The U.S. economy grew at a 3.8 percent annual rate in the final three months of 2004, faster than initially reported, because the trade deficit was smaller and businesses spent more on equipment and software.

The increase in fourth-quarter gross domestic product compares with 3.1 percent reported on Jan. 28, the Commerce Department said today in Washington.

Growth for October through December suggests the economy, which expanded at a 4 percent pace in the previous quarter, continued to perform strongly through year-end. The figures also buttress Federal Reserve Chairman Alan Greenspan's assertion in congressional testimony last week that the economy ``entered 2005 expanding at a reasonably good pace.''

``Capital expenditures are developing a head of steam,'' said former Fed Governor Lyle Gramley, now an economic advisor at the Stanford Washington Research Group in Washington. ``First-quarter GDP is going to be well above 4 percent, maybe 4.5 percent.''

The report signals faster job growth, said Ken Mayland, president of Pepper Pike, Ohio-based ClearView Economics LLC and the best overall forecaster in Bloomberg News surveys for the year ended in June. ``Now we have a track record of seven straight quarters of above-average economic growth,'' Mayland said. ``The longer that persists, the greater the chances that confidence will return and result in more normal hiring.''

The Labor Department is expected to report next week that the economy added 225,000 jobs in February, up from 146,000 in January, based on the median forecast in a Bloomberg survey.

Forecasts

Economists expected a 3.7 percent gain in GDP last quarter, according to the median of 71 estimates in a Bloomberg News survey. Signs of growth are supporting expectations the Federal Reserve will raise its benchmark interest rate at its next two meetings, after six increases since June, to 2.5 percent.

The Treasury's 4 percent note maturing in February 2015 rose 3/32 point, pushing the yield down 1 basis point to 4.27 percent at 12:25 p.m. in New York.

U.S. sales of previously owned homes, including condominiums and co-ops for the first time, declined 0.1 percent in January, the National Association of Realtors reported today in Washington.

The drop to a 6.8 million annual rate followed a 6.81 million pace in December. Sales of previously owned single-family homes declined 0.5 percent to a 5.94 million rate. The Realtors group made wide-ranging changes in how it reports its data.

Economists David Greenlaw and Ted Wieseman at Morgan Stanley in New York raised their forecast for first quarter growth to 4.1 percent from 3.3 percent, based in part on today's GDP data and earlier reports on trade and construction.

GDP Estimates

The GDP estimates are the second for the quarter and will be revised again next month. As in the previous GDP report, consumer spending, inventory building and business investment were among the main drivers of growth. For all of 2004, the economy grew 4.4 percent, the strongest since 1999, up from 3 percent in 2003. Consensus forecasts for this year put growth at about 3.6 percent, closer to the average for the past decade.

``The strength of the recovery in the face of a 25 percent run-up in oil prices is testament to the recovery's resilience,'' said Robert DiClemente, chief U.S. economist at Citigroup Global Markets Inc. ``Demand shows few, if any, signs of flagging.''

The trade deficit, which swelled to its widest ever in November, subtracted 1.4 percentage points from fourth-quarter growth instead of the 1.7 previously reported.

The drag from trade was reduced after the agency responsible for Canadian trade and GDP figures said last month that it mistakenly underreported November imports from the U.S. by C$1.31 billion ($1.06 billion).

Trade Deficit

A decline in the value of the dollar may give exports a boost this year by making U.S. goods cheaper abroad, helping stabilize the trade gap, economists said.

``Our business is strong,'' Georgia-Pacific Corp.'s chief executive, Pete Correll, said yesterday in an interview. ``The U.S. dollar is weak compared to the Canadian dollar and the euro. That's good for us. Interest rates are low. Americans are building houses. Consumers are shopping and buying our consumer goods.''

Atlanta-based Georgia-Pacific makes building materials as well as paper products such as Brawny towels and Dixie cups.

Business fixed investment, which includes spending on commercial construction as well as equipment and software, grew at a 14 percent annual rate in the fourth quarter, compared with 10.3 percent reported earlier and a 13 percent gain the prior quarter.

Inventories

Spending on equipment and software grew at an 18 percent annual rate, the fastest since the third quarter of 2003, revised from 14.9 percent. The increase followed a 17.5 percent rate in the third quarter. The back-to-back gains are the strongest since the six months that ended in September 1997.

Companies boosted inventories at a $51 billion annual rate, compared with $45.8 billion reported Jan. 28 and $34.5 billion in the third quarter.

Consumer spending, which accounts for more than two-thirds of the economy, expanded at a 4.2 percent annual pace, compared with 4.6 percent initially reported. Spending reached a three-year high of 5.1 percent in the third quarter.

The Commerce Department said it lowered the fourth-quarter figure because people bought fewer motor vehicles than previously estimated.

Consumer spending grew 3.8 percent last year, the most since 2000, after rising 3.3 percent in 2003.

Gross domestic product, the total value of goods and services generated during the period, grew to $11 trillion at an annual rate for the quarter after adjusting for inflation. It was $10.8 trillion for the year.

Outlook for Investment

Before inflation, GDP grew at a 6 percent annual pace to $12 trillion for the quarter and totaled $11.7 trillion for the year.

Income growth and business spending on new equipment will help fuel the expansion this quarter, economists said.

The economy is projected to expand at a 3.6 percent annual pace from January through March, according to the median estimate of 73 economists surveyed early this month. Last month, economists forecast a 3.5 percent pace. Growth of 3.6 percent is also projected for the year.

The implicit price deflator, a measure of prices tied to the report, rose at a 2.1 percent annual rate, revised from 2 percent, after gaining 1.4 percent in the third quarter. The personal consumption expenditures price index, a measure tied to consumer spending, rose at an unrevised 2.5 percent annual pace, after rising at a 1.3 percent pace in the prior quarter.

The index rose 1.6 percent when food and energy costs were excluded. That so-called core index rose 0.9 percent in the third quarter. For the year, it was up 1.5 percent. That's within the 1 percent to 2 percent range that Fed Governor Ben Bernanke said last night said he prefers.

Even so, the Fed ``still has a ways to go'' in raising interest rates as it seeks to ensure that inflation remains in check, Jack Guynn, president of the Federal Reserve Bank of Atlanta, said this week to the Rotary Club of Birmingham in Alabama.

The U.S. central bank's policy making arm, the Federal Open Market Committee, has boosted its benchmark overnight bank rate, currently at 2.5 percent, six times since June and pledged to make future increases at a ``measured'' pace.

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