Economy grows at a strong pace

The economy shook off surging energy costs in the second quarter to expand at a healthy pace and set the stage for solid growth in coming months, the Commerce Department reported yesterday.

As measured by the output of goods and services, or gross domestic product, the economy grew at a 3.4 percent annual rate in the three-month period ended June 30, the agency said. That was somewhat slower than the 3.8 percent rate in the first three months of the year, but comfortably above the three-year average of 2.8 percent.

Even though energy prices hit record levels in recent months, the economy managed to keep chugging along in the second quarter. Inflation-adjusted disposable income rose, sales surged, and both consumers and businesses spent at steady clips. Exports jumped, too, growing at a nearly 13 percent annual rate, the fastest growth since the end of 2003.

And in a good sign for the Massachusetts high-tech economy, business spending on equipment and software accelerated to an annual rate of 11 percent, from about 8 percent in the first quarter.

''We're seeing very strong growth momentum," said Nariman Behravesh, chief economist at Global Insight, a Waltham forecasting firm. ''This recovery has staying power."

Just a couple of months ago, many analysts weren't so sure. Persistently high oil and gasoline prices seemed to take a toll, as economic reports indicated spotty retail sales, sputtering industrial production, and slowing job growth.

But yesterday's report underscored what recent data have shown: The economy remains on a path of steady expansion and moderate inflation. Prices rose at a 3.3 percent annual rate in the second quarter, compared to 2.3 percent in the first quarter, the Commerce Department said. Excluding volatile food and energy products, prices rose just 1.8 percent, slowing from 2.4 percent in the first quarter.

In a separate report, the Labor Department reported yesterday that a key driver of inflation, wages and benefits, advanced only modestly, rising 3.2 percent in the last year, compared to a 3.9 percent increase in the previous year.

Taken together, these data suggest the Federal Reserve will continue to gradually raise interest rates, a quarter-point at time, analysts said. Most expect the Fed to boost its key short-term rate to 3.5 percent from 3.25 percent when policy makers meet next month.

The Fed already has raised its key rate nine times over the past year, and the question for analysts and investors remains when will it stop. With increasing evidence of a sustained expansion, economists expect the Fed to boost the key rate to at least 4 percent and perhaps as high as 4.5 percent.

The Fed uses interest rates to manage the economy, cutting them during downturns to spur growth, and raising them to cool inflation during expansions.

Concerns about how high rates will go weighed on stocks yesterday, as did another jump in oil prices, which hit their highest levels in weeks.

The Dow Jones industrial average fell 64.64 points to 10,640.91. The technology-heavy Nasdaq Composite index fell 13.61 points, to 2,184.83.

Some economists said yesterday's report on the economy suggests even stronger growth in the coming months since inventories declined sharply in the second quarter. With demand strong, companies will have to rebuild those inventories, helping drive further expansion, some economists said.

Robert Gavin can be reached at rgavin@globe.com.