U.S. economic growth slowed more sharply than initially thought in the second quarter, held back by the largest increase in imports in 26 years, a government report showed on Friday.

Gross domestic product expanded at a 1.6 percent annual rate, the Commerce Department said, instead of the 2.4 percent pace it had estimated last month.

However, the reading was a touch better than market expectations. Analysts polled by Reuters had forecast GDP, which measures total goods and services output within U.S. borders, revised down to a 1.4 percent growth rate. The economy grew at a 3.7 percent pace in the first three months of the year.

The slackening economic recovery is a major political challenge for the Obama administration and the Democratic Party two months away from crucial mid-term elections that could shift the balance of power in Congress in favour of Republicans.

A Reuters/Ipsos poll this week found Obama's approval rating at 45 percent overtaken for the first time by a 52 percent disapproval rating.

The revised GDP data will likely fuel analysts' concern that slowing growth is putting the economy at growing risk of slipping back into recession. Federal Reserve policymakers were meeting on Friday at their annual retreat in Wyoming to ponder the economy's direction and hear from Fed Chairman Ben Bernanke.

There is no doubt we are losing momentum in the economic recovery, said Robert Dye, senior economist at PNC Financial Services in Pittsburgh. But if we define recession as two or more consecutive declining quarters of GDP, I think we are not going to go there.

We are going to see a pattern where we may have declining GDP in one quarter followed by smaller gains in the next quarter, bouncing along the bottom as it were, Dye said.

The recovery from the worst economic downturn since the Great Depression had been largely fuelled by a $862 billion government stimulus package and businesses rebuilding inventories from record low levels.

IMPORTS CHOKING GROWTH

Growth in the last quarter was stifled by a 32.4 percent surge in imports, the largest since the first quarter of 1984, dwarfing a 9.1 percent rise in exports. That created a trade deficit, which sliced off 3.37 percentage points from GDP, the largest subtraction since the fourth quarter of 1947.

A smaller contribution from business inventories than initially estimated also restrained output. Business inventories increased only $63.2 billion, rather than $75.7 billion, adding a slim 0.63 percentage points to GDP.

Inventories, which had been a major driver of the recovery that started in the second half of 2009, increased $44.1 billion in the first three months of the year.

Excluding inventories, the economy expanded at a 1.0 percent rate, instead of the 1.3 percent pace reported last month.

There were some bright spots in the report, with growth in consumer spending revised up to a 2.0 percent rates from 1.6 percent. Consumer spending grew at a 1.9 percent rate in the first quarter.

Stubbornly high unemployment has dampened consumer spending, which normally accounts for 70 percent of U.S. economic activity. Spending added 1.38 percentage points to GDP last quarter.

Although businesses have been reluctant to hire new workers, they have been splurging on equipment and software, which also contributed to the surge in imports. Business investment was revised up to a 17.6 percent rate, the largest increase since the first quarter of 2006, from the previously estimated 17 percent pace.

Investment in equipment and software was the strongest since the fourth quarter of 1983. Spending on structures was revised to show a far smaller increase than previously estimated but still posted the first rise in spending on structures since the second quarter of 2008.

Growth in new home construction was revised down slightly to 27.2 percent from 27.9 percent. The sector, which was a drag on growth in the first quarter, was lifted by a spurt in building activity spurred by a popular home-buyer tax credit that has since expired. The rate of increase was still the biggest since the third quarter of 1983.

Residential investment had contracted at a 12.3 percent rate in the first quarter.

The GDP also showed corporate profits rose 2.9 percent in the second quarter after increasing 5.8 percent in the first three months of the year.

(Reporting by Lucia Mutikani)

Ben Bernanke