By Lucia Mutikani
WASHINGTON (Reuters) - The U.S. trade deficit dropped to its lowest level in nearly 1-1/2 years in October, suggesting trade could contribute to economic growth in the fourth quarter, though a broad decline in imports hinted at a slowdown in domestic demand.
Still, consumer spending is likely to remain supported by a strong labor market. Other data on Thursday showed the number of Americans filing claims for unemployment benefits unexpectedly fell last week, hitting their lowest level in seven months.
The reports countered data this week showing manufacturing activity contracting for a fourth straight month in November, a slowdown in growth in the services sector as well as a drop in construction spending in October. The latest data suggested the economy was growing at a moderate pace rather than stall speed.
The Commerce Department said the trade deficit tumbled 7.6% to $47.2 billion, the smallest since May 2018, as both imports and exports of goods declined. It was the second straight monthly drop in the trade bill and the percent drop was the biggest since January.
The decreases in imports and exports suggested the White House's "America First" agenda, marked by a 17-month trade war with China, was reducing trade flows, which in the long run is detrimental to domestic and global growth.
"Shrinking the trade deficit by cutting imports even faster than you cut exports is obviously not a sustainable long-term path to drive growth for any economy," said Tim Quinlan, a senior economist at Wells Fargo Securities in Charlotte, North Carolina.
Economists polled by Reuters had forecast the trade gap narrowing to $48.7 billion in October.
The goods trade deficit with China fell 1.1% to $31.3 billion, with imports unchanged and exports increasing 3.4%.
The goods trade gap with the European Union jumped 20% to $16.4 billion, with imports surging to a record high.
While Washington and Beijing are working on a "phase one" trade deal, the United States has ratcheted up tensions with other trade partners including Brazil, Argentina and France.
President Donald Trump has defended the tariffs as necessary to protect domestic manufacturers from what he says is unfair foreign competition. Trump has accused trading partners, including China, the European Union, Brazil and Argentina of devaluing their currencies at the expense of U.S. manufacturers.
Ironically, the United States has a goods trade surplus with Brazil, which swelled in October to its highest level since March 2014. It is also running a goods trade surplus with Argentina. The goods trade surplus with South and Central America hit a record high in October.
The dollar was weaker against a basket of currencies, while U.S. Treasury yields rose. U.S. stocks were trading lower amid a lack of new developments in U.S.-China trade talks.
IMPORTS, EXPORTS FALL
Trade tensions have undermined business investment, which together with slowing growth overseas has led to a recession in manufacturing.
In a second report on Thursday, the Commerce Department said factory orders increased 0.3% in October, but shipments were unchanged and unfilled orders barely rose, indicating the manufacturing downturn could persist for a while.
There are, however, no signs the trade war is significantly impacting the labor market. In a third report, the Labor Department said initial claims for state unemployment benefits dropped 10,000 to a seasonally adjusted 203,000 for the week ended Nov. 30, the lowest level since mid-April.
While the claims data has no bearing on November's employment report, scheduled for release on Friday, it underscored labor market strength.
According to a Reuters survey of economists, nonfarm payrolls probably increased by 180,000 jobs in November, boosted by the return of about 46,000 striking General Motors <GM.N> workers. The strike had helped to hold job growth down to 128,000 in October.
Employment gains have slowed this year, averaging 167,000 per month compared with an average monthly gain of 223,000 in 2018, because of ebbing demand and a shortage of workers. But the pace of hiring has been more than the roughly 100,000 jobs needed per month to keep up with growth in the working-age population.
When adjusted for inflation, the goods trade deficit decreased $3.9 billion to $79.1 billion in October, also the smallest gap since May 2018.
The drop in the so-called real trade deficit is positive for the calculation of gross domestic product. It suggested trade could add to GDP growth in the fourth quarter after being a drag for two straight quarters. The Atlanta Federal Reserve raised its fourth-quarter GDP estimate to a 1.5% annualized rate from a 1.3% pace. The economy grew at a 2.1% pace in the third quarter.
But the drivers of the decline in the trade gap in October point to softening economic fundamentals. In October, goods imports dropped 2.1% to $204.1 billion. Consumer goods imports fell $2.4 billion amid declines in cellphones and other household items, toys, games and sporting goods, as well as pharmaceutical preparations. This implies a slower pace of consumer spending after two straight quarters of brisk growth.
"The drop in imports is a double-edge sword," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "The good news is that it helped narrow the deficit, but it could also signal weakness in domestic demand."
Motor vehicle and parts imports dropped $1.8 billion. Motor vehicle parts imports accounted for most of the drop, likely reflecting the GM strike, which undercut motor vehicle production. A reversal is likely.
Goods exports fell 0.6% to $136.1 billion in October. They were led by a $0.7 billion drop in shipments of consumer goods. Motor vehicle exports and parts exports also fell. There were, however, an increase in crude oil exports, pushing the petroleum surplus to a record high.
The services surplus widened to $20.8 billion in October from $20.6 billion in September.
(Reporting By Lucia Mutikani; Editing by Andrea Ricci)