By Lucia Mutikani
WASHINGTON (Reuters) - The trade deficit widened in October as exports suffered the biggest drop in nearly four years, indicating slowing global demand was spilling over into the already struggling U.S. economy.
The Commerce Department said on Tuesday the trade gap increased 4.9 percent to $42.2 billion. In a sign of weak domestic demand, imports hit the lowest level in 1-1/2 years.
"The report tells a tale of weakening economic growth momentum both domestically and globally," said Millan Mulraine, a senior economist at TD Securities in New York.
Economists, who had expected the trade deficit to widen to $42.6 billion in October, said superstorm Sandy could have disrupted trade flows. The storm, which struck the East Coast in late October, shut ports in New York and New Jersey.
However, the Commerce Department did not indicate that Sandy was a factor. The wider trade gap in October reflected a 3.6 percent fall in exports of goods and services to $180.5 billion. That was the biggest percent drop in exports since January 2009.
Exports have been one of the pillars supporting the economy since the 2007-09 recession ended. The pull back in October's export growth was telegraphed by weak manufacturing surveys and reflects slowing global demand.
Imports of goods and services fell 2.1 percent to $222.8 billion in October, the lowest since April 2011. Economists said the decline in imports was hardly surprising, given a weakening in consumer demand in recent months.
Fears that tighter fiscal policy, set to kick in early next year, could push the economy into recession have sapped domestic demand and caused businesses to cut back on spending.
Trade was a modest boost to the third quarter's 2.7 percent annual growth pace. Revisions to September's data showed a narrower trade gap than previously reported and suggest the contribution from trade was probably slightly bigger.
NEUTRAL GROWTH IMPACT
In October, the inflation-adjusted trade deficit narrowed to $46.2 billion from $46.6 billion in September. While that implied trade would make another small contribution to gross domestic product in the fourth quarter, economists said the size of the drop in exports raised the bar high for that.
In addition, a strike by West Coast dock workers in late November and early December likely reduced trade last month.
"Looking through all these distortions, trade is going to be neutral on growth," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester Pennsylvania.
The three-month moving average of the trade deficit, which irons out month-to- month volatility, widened modestly to $41.7 billion from $41.5 billion in the three months to September.
WHOLESALE INVENTORIES UP, SALES DOWN
Weak domestic demand was underscored by a 0.6 percent rise in wholesale inventories in October, which came as sales fell for the first time in three months, a second Commerce Department report showed.
That pushed the inventories/sales ratio, a measure how long it would take wholesalers to clear their warehouses, to a three-year high. Inventories accounted for more than a quarter of the economy's annual 2.7 percent growth pace in the third quarter.
October's restocking at wholesales suggested the hit to GDP growth from inventories would probably not be as big as initially feared, economists said.
"We got a big inventory buildup in the third quarter and some of that was unwanted. Businesses will probably be content to draw down their inventories to meet demand," said Sweet.
"We are seeing the drivers of growth shifting away from business investment, inventories and trade to a more consumer-led recovery, but they won't be able to really drive growth over the next few months because of concerns about the fiscal cliff."
A third report showed confidence among small business owners dived in November and economists pinned that on the fears of deep government spending cuts and higher taxes which could drain about $600 billion from the economy early next year.
The National Federation of Independent Business said on Tuesday its optimism index plummeted 5.6 points to 87.5 last month, the weakest reading since March 2010.
While U.S. exports to the 27-nation European Union rose 1.4 percent in October, there were substantial declines in goods shipped to France, Germany, Italy and the United Kingdom. Exports to the EU in the first 10 months of 2012 were down 0.7 percent compared to same period in 2011.
However, the Commerce Department only reports goods trade balances with individual countries and regions on a not seasonally adjusted basis.
U.S. exports to Latin America also fell in October, and shipments to Japan were down 8 percent.
Although exports to China, which have been growing more slowly than in recent years, surged 23.1 percent in October, imports rose to a record. That pushed the contentious U.S. trade deficit with China to a record $29.5 billion.
(Reporting By Lucia Mutikani; Editing by Neil Stempleman)