The initial estimate of third-quarter growth in the US economy came in at an annualized 3.5% expansion in GDP — strong enough that analysts expected it to drop in the second pass even though Q2’s final GDP was 4.6%. Instead, the BEA’s revised estimate put growth in Q3 at 3.9%, making the past two quarters the strongest since the start of the Great Recession:

Real gross domestic product — the value of the production of goods and services in the United States, adjusted for price changes — increased at an annual rate of 3.9 percent in the third quarter of 2014, according to the “second” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 4.6 percent.

The GDP estimate released today is based on more complete source data than were available for the “advance” estimate issued last month. In the advance estimate, the increase in real GDP was 3.5 percent. With the second estimate for the third quarter, private inventory investment decreased less than previously estimated, and both personal consumption expenditures (PCE) and nonresidential fixed investment increased more. In contrast, exports increased less than previously estimated (see “Revisions” on page 3).

The increase in real GDP in the third quarter reflected positive contributions from PCE, nonresidential fixed investment, federal government spending, exports, residential fixed investment, and state and local government spending that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased.

The deceleration in the percent change in real GDP reflected a downturn in private inventory investment and decelerations in exports, in nonresidential fixed investment, in state and local government spending, in PCE, and in residential fixed investment that were partly offset by a downturn in imports and an upturn in federal government spending.

The most impressive part of the report is the real final sales of domestic product. This measures actual growth after stripping out inventory adjustments and gives a clearer idea of demand. For most of the past five years, any significantly positive GDP figures have shown a big inventory shift that accounts for a large part of it. In this quarter, though, real final sales outstripped the overall GDP slightly, coming in at 4.1%. That’s an improvement from Q2’s 3.2%, and the best number in at least four years.

Reuters notes that this is actually the best two-quarter period since 2003, when Bush’s economic policies began to bear fruit:

Growth had increased at a 4.6 percent rate in the second quarter. The economy has now experienced the two strongest back-to-back quarters of growth since 2003.

Economists polled by Reuters had expected growth would be cut to a 3.3 percent pace.

Inventories were also revised higher, with restocking now only accounting for a mild drag to GDP growth. That also helped to offset downward revisions to export growth.

Inventories, however, could weigh on growth in the final three months of the year. Spending on residential construction was also revised higher.

It was the fourth quarter out of the past five that the economy has expanded above a 3.5 percent pace. Data ranging from manufacturing to employment and retail sales suggest the economy retained some of that momentum early in the fourth quarter.

The upward adjustment came from better-than-estimated consumer spending and investment. That bodes well for the near future, especially as the Christmas holiday retail season arrives. This could be a good season for retailers, who have weathered plenty of body blows over the past seven years of recession and stagnation.

AFP steals Reuters’ U-word, but in a different way:

Gross domestic product growth for July-September was revised from the initial estimate of a 3.5 percent annual rate, following 4.6 percent in the second quarter.

The number was unexpected; economists had predicted that the second official estimate for the quarter would be pared to 3.2 percent.

Contributing to the improved number was an upward revision to business inventory investment, especially in the wholesale trade and retail trade sectors.

The question now will be whether the Federal Reserve feels comfortable enough to get its rates off of zero for the first time in years. Money News notes that the Fed has been using a variant of the so-called Taylor Rule to guide their interest rate decisions, which uses a calculation that balances inflation rates and economic slack, the latter of which has a fairly flexible definition. The two-quarter rise may now indicate to the Fed that it needs to set interest rates as high as 1.5% in the near future — or stand pat at zero:

Using the gap between the economy’s potential rate of growth and its actual growth, the Taylor rule currently suggests a policy rate that’s about a half of a percentage point below zero, the paper shows.

But using the gap between the actual unemployment rate and the lowest unemployment rate the economy can withstand without generating inflation, the Taylor rule currently prescribes a policy rate of about 1.5 percent, the paper shows.

“Determining whether the economy is overheating or underperforming is critical for monetary policy,” Early Elias, Helen Irvin and Oscar Jorda, the authors of the paper, wrote. “Our analysis highlights the difficulties of using the Taylor rule as a practical guide to implementing monetary policy in real time.”

The next Fed meeting will get lots of attention, but given the circumstances, perhaps its first positive attention in years.