Consumers hold back growth, rebound seen muted,(Reuters) - Unexpectedly weak consumer spending hobbled the economy in the first quarter and fresh sig

(Reuters) - Unexpectedly weak consumer spending hobbled the economy in the first quarter and fresh signs of a slowdown in the labor market pointed to an uphill struggle for the recovery.

The economy grew at an annual 1.8 percent rate in the first three months of this year, the Commerce Department said on Thursday, unchanged from an earlier estimate and weaker than most forecasts.

A separate report from the Labor Department showed the number of Americans claiming unemployment benefits unexpectedly rose last week by 10,000 to 424,000.

Some of the slowdown in growth was linked to bad weather in early 2011 and an 11.7 percent drop in defense spending, trends which are expected to reverse in the second quarter.

But economists were less hopeful about the expected bounce-back in growth, citing the rise in jobless claims and a moderation in factory output, which has been hit by disruptions to supply chains after the March earthquake in Japan.

"The second-quarter rebound is likely to be muted," said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts.

Estimates for second-quarter gross domestic product growth currently range between 2.5 percent and 3.5 percent but could be revised down. Recent data, including retail sales and regional manufacturing surveys, all point to soft growth.

The economy expanded at a 3.1 percent rate in the October-December period. Economists had expected the first-quarter pace to be revised up to 2.1 percent.

WEAK CONSUMER SPENDING

Investors on Wall Street brushed aside the data and bought stocks. U.S. government bond prices rallied, getting a boost by flight-to-safety buying on concerns about the European sovereign debt crisis. The dollar fell against a basket of currencies.

Despite the economy's seven straight quarters of expansion, growth has been tepid by historical standards, leaving both the Obama administration and opposition Republicans scrambling for ideas to put it on a faster track.

The White House on Thursday announced measures to reduce the costs of complying with government regulations for businesses, while Republican lawmakers unveiled job-creation proposals -- which were largely a repackaging of policies they have long advocated.

Consumer spending -- which accounts for more than two-thirds of U.S. economic activity -- expanded at a 2.2 percent rate in the first three months of this year, slower than the previously reported 2.7 percent.

After rising at a 4 percent clip in the fourth quarter, spending was clipped by high food and gasoline prices, which sent inflation soaring at its fastest pace in 2-1/2 years.

The personal consumption expenditures price index rose at an unrevised 3.8 percent rate in the first quarter. That compared to the fourth quarter's 1.7 percent increase.

The core PCE index, which is closely watched by the Federal Reserve, advanced at a 1.4 percent rate, the quickest pace since the fourth quarter of 2009.

Fed officials would like to see this measure close to 2 percent. The slower growth pace means the U.S. central bank will be in no hurry to raise interest rates once it concludes its $600 billion, government bond-buying program in June.

"This may put off the day where the Fed starts normalizing interest rates until even further down the road," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York. "The Fed is going to want to see GDP above 3 percent certainly before taking their foot off the gas."

Although consumer spending pulled back in the first quarter, economists are hopeful that a recent cooling of energy and food prices will ease the burden on household budgets and boost spending.

The soft consumer spending overshadowed a $52.2 billion increase in business inventories, which was well above the initially reported $43.8 billion rise.

But a decline in vehicle production so far in this quarter because of shortages of parts from Japan could cause a drawdown in inventories and weigh on growth in the April-June period.

Motor vehicle output added 1.28 percentage points to first-quarter GDP.

The GDP report also showed after-tax corporate profits fell at a rate of 0.9 percent in the first-quarter after rising at a 3.3 percent pace in the fourth quarter.

The drop in profits, the first since the fourth quarter of 2008, likely reflected a slowdown in productivity growth as businesses stepped up hiring. Economists had expected corporate profits to grow at a 2.3 percent pace.

However, last week's rise in initial claims suggested the pace of hiring might be slowing. Economists had forecast claims slipping to 400,000. Last week marked the seventh straight week in which claims topped the 400,000 level which economists say is normally associated with steady job growth.

"The weakness in the jobless claims data has persisted too long to ignore and suggests that the labor market, which had been a bright spot in the first quarter, is turning a bit softer in the second quarter," said Michael Feroli, an economist at JPMorgan in New York.