Chrysler Auto Sales Up 12 Percent in August

In another report, the Federal Reserve said strong demand for autos helped keep the economy on a "modest to moderate" growth path in recent weeks, an assessment that leaves the door open for a reduction in the central bank's bond purchases.

Auto sales rose 17 percent last month to a seasonally adjusted annual rate of 16.1 million units. That was the fastest pace since October 2007 and beat the 15.8 million-unit rate analysts surveyed by Reuters had expected.

It was also the latest sign that economic activity is picking up after hitting a speed bump in July and supported stocks and bond yields, although the dollar fell from a six-week high against a basket of currencies as investors looked forward to a key jobs report on Friday.

Auto sales are a key leading indicator of consumer spending, which accounts for about 70 percent of U.S. economic activity.

"We continue to head in the right direction," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "With vehicle sales above 16 million (and) a slow but steadily improving job market, the Fed is going to feel comfortable tapering in September."

The central bank has been buying $85 billion in bonds each month to keep borrowing costs low. It is widely expected to reduce that amount when officials meet later this month and a strong gain in hiring for August would cement those bets.

A raft of weak data for July, including figures on consumer spending, industrial output, durable goods orders and homebuilding, had prompted economists to downgrade their third quarter growth estimates to as low as a 1.5 percent annual pace.

But the strong vehicle sales suggested those forecasts could undershoot.

"It may be a sign that the consumer will add more to growth this quarter than we initially thought," said Sweet. The economy grew 2.5 percent in the second quarter.

The auto sector's good fortunes were captured in the Fed's Beige Book report, which found strong demand for motor vehicles lifted spending in most parts of the country in early July through late August.

The report, prepared for the Fed's September 17-18 meeting and based on information collected from its business contacts nationwide, said several of the central bank's 12 districts reported strong demand for auto-related products.

AUTOS DRIVE GROWTH

"Chicago highlighted the auto industry as a main source of strength for that district's overall manufacturing sector, and contacts there expect demand for heavy and medium trucks to ratchet up further and to support growth in overall manufacturing for the remainder of the year," the Fed said.

In Cleveland, there were reports motor vehicle parts suppliers and assembly plants would need to expand capacity in order to meet demand, it said.

The strong sales reported by car makers and the Beige Book's findings backed up a survey from the Institute for Supply Management on Tuesday showing an acceleration in manufacturing activity in August, driven by sturdy gains in new orders.

"The relatively positive tone on the manufacturing sector appears quite consistent with the underlying theme of the recent ISM manufacturing sector reports, and is likely to be seen as an early signal of a more meaningful upturn in activity in the coming months," said Millan Mulraine, senior economist at TD Securities in New York.

"It will add to the other economic reports showing steady progress in the recovery, and pointing to some modest upside momentum for growth in the coming months."

Strong demand for autos also fueled import growth in July, helping to drive up the nation's trade deficit. The Commerce Department said the trade deficit widened 13.3 percent to $39.1 billion.

Auto imports reached an all-time high, and overall imports rose 1.6 percent.

Exports slipped 0.6 percent even as exports of petroleum products hit a record high and the country sold more food and industrial supplies.

A widening trade gap usually subtracts from GDP, the deficit held near its second quarter average, suggesting trade would likely have little effect on third-quarter economic growth.

(Reporting by Lucia Mutikani, additional reporting by Bernie Woodall and Ben Klayman in Detroit; Editing by Andrea Ricci and Krista Hughes)