(Adds details, analyst comments, updates markets)
* Goods trade deficit with China falls 16.2 percent in March
* Overall trade deficit rises 1.5 percent to $50.0 billion
* Goods exports increase 1.4 percent; imports up 1.2 percent
By Lucia Mutikani
WASHINGTON, May 9 (Reuters) - The U.S. goods trade deficit with China, a focus of the White House's "America First" agenda, shrank to its smallest in five years in March, which could embolden President Donald Trump as he escalates his trade war on Beijing.
The report from the Commerce Department on Thursday came as the United States and China began two days of make-or-break talks to salvage a faltering trade deal.
Trump said on Thursday he would start paperwork to launch tariffs on a new $325 billion category of Chinese imports previously untouched by the trade feud. This is in addition to an expected increase of duties on $200 billion worth of Chinese goods to 25 percent from 10 percent on Friday. China has promised to retaliate if the tariffs are imposed.
"This (narrowing deficit) could allow President Trump to assert that the tariffs in place are having the intended effect as negotiations between the U.S. and China intensify today in Washington," said Scott Anderson, chief economist at Bank of the West in San Francisco.
The politically sensitive goods trade deficit with China decreased 16.2 percent to a seasonally unadjusted $20.7 billion, the lowest level since March 2014, as exports, including soybeans, surged 23.6 percent. Imports from the world's No. 2 economy fell 6.1 percent.
Washington last year imposed tariffs on $250 billion worth of goods imported from China, with Beijing hitting back with duties on $110 billion worth of American products. China initially targeted U.S. soybean exports, but later committed to buy more of the crop as trade negotiations proceeded.
China is the world's biggest buyer of soybeans. Economists said the latest flare-up of trade tensions could undercut soybean exports, which rose by $0.5 billion in March.
"In the near-term, trade frictions might arrest the recent ramp-up of soybean exports from the U.S. to China," said Andrew Hollenhorst, an economist at Citigroup in New York. "This would be in addition to some expected softer demand from China as African swine fever has reduced feed requirements."
The overall trade deficit increased 1.5 percent to $50.0 billion in March. Economists polled by Reuters had forecast the trade shortfall widening to $50.2 billion that month. The goods trade deficit increased 0.7 percent to $72.4 billion in March.
The trade data have been volatile in recent months, with big swings between exports and imports because of Washington's conflicts with trading partners, including the European Union, Mexico and Canada. The goods trade deficit with Mexico hit a record high of $9.5 billion in March.
When adjusted for inflation, the overall goods trade deficit increased $0.5 billion to $82.1 billion in March.
The dollar was trading lower against a basket of currencies as investors cautiously watched the trade talks in Washington, while U.S. Treasury prices rose. Stocks on Wall Street fell.
The government reported last month that trade contributed 1.03 percentage points to the economy's 3.2 percent annualized growth pace in the first quarter. While another report on Thursday from the Commerce Department showed wholesale inventories were weaker than initially thought in March, data for February was revised higher.
As a result, economists expect the advance GDP growth estimate could be trimmed to about a 3.1 percent pace when the government publishes its revision later this month. They had previously expected first-quarter GDP growth would be lowered to around a 2.9 percent pace.
While the economy continued to expand early in the second quarter, there are signs the labor market could be slowing after April's hefty employment gains. Underlying inflation also appears to be firming, which bolsters Federal Reserve Chairman Jerome Powell's views that recent weak inflation readings "may wind up being transient."
The Fed last week kept interest rates unchanged and signaled little desire to adjust monetary policy anytime soon. Initial claims for state unemployment benefits decreased 2,000 to a seasonally adjusted 228,000 for the week ended May 4, the Labor Department said in other data on Thursday.
The producer price index for final demand increased 0.2 percent last month after jumping 0.6 percent in March. A key gauge of underlying producer price pressures that excludes food, energy and trade services increased 0.4 percent last month, the largest rise since January 2018, after being unchanged in March.
"The data support the Fed chairman's argument that some of the recent slowing in core PCE inflation was due to transitory factors," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics in White Plains, New York, referring to the Fed's preferred inflation measure. "That said, underlying trends are not showing significant strengthening or weakening."
The rise in the overall trade deficit in March came as both exports and imports increased. Goods exports rose 1.4 percent to $141.7 billion. They were driven by shipments of industrial supplies and materials, as well as soybeans.
But shipments of civilian aircraft fell and further declines are likely after Boeing suspended deliveries of its troubled 737 MAX aircraft. The MAX planes have been grounded indefinitely following two deadly crashes.
Goods imports rose 1.2 percent to $214.1 billion in March. There were increases in imports of crude oil. Food imports hit an all-time high of $13.1 billion. Consumer goods imports, however, fell amid declines of cellphones and other household goods.
Reporting By Lucia Mutikani; Editing by Andrea Ricci