WASHINGTON (Reuters) - U.S. economic growth was much stronger last quarter than first thought as spending rose more than estimated, while divergent inflation signals in government and private-sector data on Wednesday left economists puzzled over price pressures.

Gross domestic product, a measure of all goods and services produced within U.S. borders, grew at a revised 4.3 percent annual rate in the July-to-September period, the fastest pace since the first three months of 2004, the Commerce Department said. That report also showed inflation was milder than first thought.

The core price index for consumer spending, the Federal Reserve's favored inflation yardstick that strips out volatile food and energy prices, rose just 1.2 percent in the third quarter, down from the originally reported 1.3 percent pace.

That was the lowest rate of core inflation in more than two years. Economists had expected the index to be revised higher.

However, data from the private sector showed prices paid by businesses in the Midwest rose in November to their highest level in 26 years while business activity eased, suggesting it may be too early to dismiss the threat of inflation.

The National Association of Purchasing Management-Chicago said its business barometer came in at 61.7, compared with 62.9 in October and with Wall Street expectations for a reading of 60.0. The prices paid index surged to 94.1, a 26-year high, from 79.6 in October.

The Commerce Department report also showed Gulf Coast hurricanes Katrina and Rita hit corporate profits in the quarter ending September 30.

Treasury bond prices, initially lifted by indications in the GDP data that prices were tame, dipped on signs of inflation pressures in the Chicago PMI number which were seen as keeping the Federal Reserve on an upward path for now.

Blue-chip stocks followed suit, weighed down by similar worries.

"It's certainly a concerning reading," said Dana Johnson, chief economist at Comerica in Detroit. "Most of what we are seeing there is the impact of higher natural gas and other energy prices."

The dollar was little changed despite the upbeat news on economic growth.

In its first snapshot a month ago, the government had pegged third-quarter growth at 3.8 percent and Wall Street economists had expected the rate to be revised up more modestly, to 4.0 percent. The sharp upward bump took growth a full point above the second-quarter's 3.3 percent rate.

"Clearly the economy had a good head of steam on it right through the hurricane period," said Alan Ruskin, research director at 4CAST Ltd in New York.

FEDERAL RESERVE MUST BE ON GUARD

"It's another reminder that the Fed has to remain alert to pricing pressures," said Brian Garvey, senior currency strategist at State Street in Boston of the Chicago PMI number. "(Policy-makers must) remain on guard to prevent expectations that the rate cycle is nearly over, given that they could be blindsided by an inflation scare in the first quarter."

The Fed has raised short-term interest rates 12 times since mid-2004 in a bid to keep price rises in check, but many analysts suspect the rate-hike campaign is nearing an end.

While the GDP report reinforced the view the U.S. economy is on a solid footing, economists expect growth to cool in the fourth quarter and into 2006 as the housing market starts to fade and consumers pull back.

"That is one factor that will probably help the Federal Reserve eventually conclude its monetary tightening cycle," said Patrick Fearon, senior economist at A.G. Edwards & Sons in St. Louis.

The Commerce Department report said after-tax corporate profits fell 3.7 percent, the largest decline in four years, after a 5.3 percent rise in the second quarter. Profits were cut by $151.2 billion at an annual rate because of hurricanes Katrina and Rita, as insurance companies made huge benefits payments and uninsured corporate property was lost.

The strong GDP growth was attributed to higher spending by both businesses and consumers. Consumer spending advanced at a solid 4.2 percent pace, above the 3.9 percent rate first reported. Spending on housing grew at an 8.4 percent pace, up from the 4.8 percent growth first reported, after a 10.8 percent surge in the second quarter.

Business spending was also robust, climbing at an 8.8 percent pace, above the initially estimated 6.2 percent growth.

(Additional reporting by Pedro Nicolaci da Costa in New York)