The U.S. economy grew in the third quarter for the first time in more than a year as government stimulus helped lift consumer spending and home building, fueling an unexpectedly strong advance.

Signaling the end of the worst recession in 70 years, the Commerce Department on Thursday said the economy expanded at an annual rate of 3.5 percent in the July-September period, snapping four down quarters with its fastest growth pace since the third quarter of 2007 and exceeding forecasts for a 3.3 percent rate.

The report helped lift global stock markets which were also boosted by improving third-quarter corporate earnings, including higher-than-expected profits from household goods makers Procter & Gamble Co and Colgate-Palmolive Co.

On Wall Street, the broad S&P 500 index of U.S. stocks had gained more than 1 percent in morning trade after four days of falls caused by investor concerns over the outlook for economic growth.

Prices for U.S. government debt and the U.S. dollar fell as traders exited safe havens.

The economy has emerged with gusto from the deepest recession since World War Two, said Harm Bandholz, economist at UniCredit Markets and Investment Banking in New York. The short-term prospects for the economy remain good.

Growth was generally broad-based with solid gains in consumer spending, exports and home construction.

But, worryingly for economists, it was also driven by emergency government programs like the popular cash for clunkers incentive for new auto purchases and an $8,000 tax credit for first-time home buyers.

The auto discount program ended in August and the home tax credit is due to expire next month, although Congress is working on a plan to extend it.

Stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter.

The economy is entirely dependent on federal deficit spending at the moment. But the stimulus will not fade right away ... that means we can rely on solid growth continuing through the first quarter of next year, said Chris Low, chief economist at FTN Financial in New York.

Once the government steps aside, growth is likely to fall back to a 1-2 percent rate of growth.

The United States is entering recovery following in the footsteps of major economies like China and the euro zone.

For a graphic see http://graphics.thomsonreuters.com/109/US_GDP1009.gif

MORE WORK NEEDED

Data on Thursday showed German unemployment fell unexpectedly in October and Japanese industrial output rose for the seventh straight month in September.

The Obama administration, which has directed a $787 billion stimulus package to the economy, said more work was needed.

For every person out of work, for every family facing foreclosure, for every small business facing a credit crunch, the recession remains alive and acute, Treasury Secretary Timothy Geithner told the Senate's Finance Committee.

Officials from the Federal Reserve -- the U.S. central bank -- meet next Tuesday and Wednesday and will sift through the economic tea leaves to try to determine whether a sustainable recovery is building. They are widely expected, however, to keep stimulative monetary policies in place for some time.

Consumer spending, which normally accounts for more than two-thirds of U.S. economic activity, rose 3.4 percent in the third quarter, the fastest advance since the first quarter of 2007. Spending fell 0.9 percent in the previous quarter.

Residential investment jumped 23.4 percent, contributing to GDP for the first time since 2005, after declining 23.3 percent in the April-June period. It was also the sharpest rise since the second quarter of 1986.

A housing slump had been the main drag behind the economy's downturn. A sharp slowing in the pace of inventory liquidation by businesses also supported recovery in the third quarter.

Business inventories fell $130.8 billion, slowing from the record $160.2 billion plunge in the second quarter. The change added nearly 1 percentage point to the growth in GDP.

Analysts are hoping that the slowdown in the inventory decline by businesses will continue to prop up the economy in the fourth quarter, even as consumer spending is expected to retreat amid the worst labor market in 26 years.

Longer term, inventory stabilization buys time to generate the conditions, most importantly job and income growth, for a sustained healthy expansion, said Stephen Stanley, chief economist at RBS in Greenwich, Connecticut.

As such, a turnaround in the labor market is the last key piece of the puzzle that needs to fall into place to support a solid economic recovery.

With inventories at a lean level, any advance in consumer spending is more likely to lead to an increase in output.

Excluding inventories, GDP rose at a 2.5 percent rate compared to a 0.7 percent increase in the second quarter.

The weaker dollar boosted exports but a rise in imports subtracted from real GDP. Federal government spending helped growth but both state and local governments were a drag.

Business investment fell at a 2.5 percent pace with spending on nonresidential structures dropping at a 9 percent rate. A lack of credit has hit the U.S. commercial property market hard.

The Labor Department said on Thursday the number of U.S. workers filing new claims for jobless benefits dipped by 1,000 last week to 530,000, above expectations of a drop to 521,000.

However, the number of people still on jobless aid after an initial week of benefits slid by 148,000 to 5.8 million in the week ended October 17. It was the lowest reading since March, hinting at some stability in the job market.

(Additional reporting by Alister Bull; Editing by Andrea Ricci)

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