THE US economy grew at an annualised rate of 4.2 per cent in the second quarter, its fastest for two years, the Commerce Department said yesterday.

President Clinton hailed the figures as "more evidence that our economy continues to surge ahead and that our economic strategy is working".

In financial markets, investors took heart from tentative signs that growth might slow in the third quarter, reducing pressure on the Federal Reserve to raise short term interest races.

Share and bond prices rose sharply following a report showing an unexpected decline in an index known to be monitored by Mr, Alan Greenspan, the Fed chairman.

The Purchasing Managers' index fell to 50.2 per cent from 54.3 per cent in June, indicating a slowdown in manufacturing last month. Readings of about 50 per cent indicated zero growth in factory output.

Investors were encouraged by a fall in a part of the index measuring commodity prices. The data on gross domestic product also showed an easing of inflationary pressures in the second quarter.

By midday, the 30 year Treasury bond was up more than a point, pushing the yield down to 6.842 per cent. The Dow Jones Industrial Average was up 27.37 at 5,556.28, having risen more than 50 points in earlier trading.

The 4.2 per cent growth rate exceeded Wall Street expectations and followed revised estimates of 2 per cent and 0.3 per cent in preceding quarters.

The expansion was broadly based, with consumer spending growing at an annualised rate of 3.7 per cent, up from 3.5 in the first three months.

The increase would have been faster but for a slowdown in business capital spending and a widening of the trade deficit.

Analysts said the Fed's decision on interest rates would depend on its assessment of the economy's current momentum. The central bank is looking for signs that growth is slowing to 2-2.5 per cent, seen as consistent with stable inflation.