WASHINGTON, April 28 (Reuters) - U.S. economic growth braked sharply in the first quarter to its slowest pace in two years as consumer spending softened and a strong dollar continued to undercut exports, but a pick-up in activity is anticipated given a buoyant labor market.
Gross domestic product increased at a 0.5 percent annual rate, the weakest since the first quarter of 2014, the Labor Department said on Thursday in its advance estimate, also as businesses stepped up efforts to reduce unwanted merchandise clogging up warehouses.
The economy was also blindsided by cheap oil, which has hurt the profits of oil field companies like Schlumberger and Halliburton, resulting in business spending contracting at its fastest pace since the second quarter of 2009, when the recession was ending.
"Although growth was weak to start the year, the soggy results are consistent with seasonal trends over the past decade. Expectations for growth for the remainder of the year remain bright," said Jim Baird, chief investment officer at Plante Moran Financial Advisors in Kalamazoo, Michigan.
Economists polled by Reuters had forecast the economy expanding at a 0.7 percent rate in the first quarter. The economy grew at a 1.4 percent pace in the fourth quarter.
Almost all sectors of the economy weakened in the first quarter, with the housing market the lone star.
But the slowdown in growth could be temporary, given a fairly robust jobs market. A separate report from the Labor Department showed first-time applications for unemployment benefits rose less than expected last week and the four-week average of initial claims fell to its lowest level since 1973.
Employment gains averaged 209,000 jobs per month in the first quarter. Also suggesting a pickup in growth in the second quarter, the Institute for Supply Management's manufacturing and nonmanufacturing surveys, which are closely correlated to economic activity, rebounded in recent months.
While the Federal Reserve on Wednesday acknowledged economic activity had "slowed," it also said labor market conditions had "improved further." The U.S. central bank appeared to view the threats from the global economy and financial markets as having diminished.
The Fed left its benchmark overnight interest rate unchanged and suggested it was in no hurry to tighten monetary policy further. It hiked rates in December for the first time in nearly a decade.
Economists also believe the model used by the government to strip out seasonal patterns from data is not fully accomplishing its goal despite recent steps to address the problem.
Residual seasonality has plagued first-quarter GDP, with growth underperforming in five of the last six years since the recovery started in mid-2009.
U.S. government bond prices rose marginally, while the dollar was little changed against a basket of currencies.
CONSUMER SPENDING COOLS
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, increased at a 1.9 percent rate. That was the slowest since the first quarter of 2015 and marked a deceleration from the fourth quarter's 2.4 percent rate.
Households have been frugal, cutting back on purchases of long-lasting manufactured goods like automobiles, despite cheap gasoline. Households appear to have socked away modest wage gains from the tightening labor market and the gasoline savings. They have also reduced their debt.
Income at the disposal of households after accounting for taxes and inflation increased 2.9 percent in the first quarter after rising 2.3 percent in the prior period. Savings rose to a lofty $712.3 billion from $678.3 billion in the fourth quarter.
Higher savings and a lower debt load augur well for an acceleration in consumer spending.
Despite consumer spending softening, inflation picked up in the first quarter. A price index in the GDP report that strips out food and energy costs increased at a 2.1 percent rate, the fastest since the first quarter of 2012 and an acceleration from the fourth quarter's 1.3 percent pace.
With consumer spending tepid, businesses continued to place fewer orders for goods and ramped up efforts to reduce an inventory bloat. In the first quarter, businesses accumulated $60.9 billion worth of inventory, down from $78.3 billion in the fourth quarter.
The small inventory build cut 0.33 percentage point from first-quarter GDP growth, up from the 0.22 percentage point drag in the fourth quarter. Still, inventories remain high and could be a drag on growth in the second quarter.
Trade subtracted 0.34 percentage point from GDP growth in the last quarter, with dollar strength weighing on exports and sucking in imports. The dollar gained 20 percent versus the currencies of the United States' trading partners between June 2014 and December 2015.
So far this year the dollar is down 2.6 percent on a trade- weighted basis, raising optimism for a rebound in exports.
A sustained plunge in energy sector investment piled pressure on business spending. Investment in equipment tumbled at an 8.6 percent rate, the steepest decline since the second quarter of 2009.
Investment in nonresidential structures dropped at a 10.7 percent pace as spending on mining exploration, wells and shafts collapsed at a record 86 percent rate. Investment in mining exploration contracted at a 39.6 percent rate in the fourth quarter.
There were strong gains in residential investment in the first quarter, the only bright spot in the economy.
(Reporting by Lucia Mutikani; Editing by Andrea Ricci)