GDP unexpectedly shrinks, decline seen temporary

WASHINGTON (Reuters) - The economy unexpectedly contracted in the fourth quarter, but analysts said there was no reason for panic given that consumer spending and business investment picked up.

Gross domestic product fell at a 0.1 percent annual rate, its weakest performance since it emerged from recession in 2009, the Commerce Department said on Wednesday.

If it were not for the hit from slower inventory growth and the deepest plunge in defense spending in 40 years, the economy would have grown at a respectable 2.5 percent rate. The weight from those two factors is expected to lessen in the first three months of this year.

Economists said Superstorm Sandy, which struck the East Coast in late October may have cut about half a point off GDP, but the department said it was difficult to quantify the impact.

"Obviously, the headline number is a bit jarring, but the underlying details of the report, by and large, are consistent with an economy that is growing probably at a trend basis of about two percent," Michael Hanson, a senior economist at Bank of America Merrill Lynch in New York.

Economists polled by Reuters had expected GDP to rise at a 1.1 percent rate and none had predicted a contraction.

U.S. financial markets largely shrugged off the decline in output, heartened by the acceleration in consumer spending and the rebound in business investment, which pointed to some fundamental economic strength.

A second report from payroll processor ADP showed private-sector payrolls expanded by 192,000 jobs in January after increasing 185,000 in December.

Faster jobs growth could help the economy to weather the headwind of higher taxes and possible spending cuts this year. A payroll tax cut expired on January 1 and big automatic spending cuts are set to take hold in March unless Congress acts.

Federal Reserve officials, at the end of a two-day meeting, noted economic activity had "paused" due to weather-related disruptions and other "transitory factors." They expressed confidence the recovery would regain speed with continued monetary policy support, and they left in place their monthly $85 billion bond-buying stimulus plan.

Economists say a growth pace in excess of 3 percent would be needed over a sustained period to significantly lower high unemployment. For the whole of 2012 the economy grew 2.2 percent, and a report on Friday is expected to show the jobless rate held at 7.8 percent for a third straight month in January.

INVENTORY DRAG

In the fourth quarter, the recovery had to deal with uncertainty over the so-called fiscal cliff of scheduled tax hikes and budget cuts, which hurt confidence even though households and businesses seemed to shrug off the worries.

Businesses, caught with too much inventory on their hands in the third quarter, slowed their stock building in the final three months of the year. That slowdown reduced GDP growth by 1.27 percentage points, the most in two years.

But with the pick-up in consumer spending in the fourth quarter, businesses now will need to replenish stocks, which should help lift growth early this year.

"Today's number actually leaves the economy relatively well-positioned heading into the first quarter," said Michael Feroli, an economist at JPMorgan in New York.

"The slowing in the pace of inventory accumulation means that businesses will not have to pull back on production as much in the first quarter if consumer spending does downshift in response to the recent tax increases."

Many forecasters think the economy will grow only around a 1 percent pace in the first quarter but then strengthen.

The GDP report showed government spending tumbled at a 6.6 percent rate, with defense outlays plunging at a 22.2 percent pace, the largest drop since the third quarter of 1972.

Trade also cut into the economy, slicing a quarter of a percentage point off the change in GDP. Exports, which have been hampered by a recession in Europe, a cooling Chinese economy and storm and strike-related port disruptions, fell for the first time since the first quarter of 2009.

Caterpillar Inc, the world's largest maker of construction equipment, reported a sharp drop in quarterly profits, citing weak demand in China as one reason for the decline.

PLENTY OF POSITIVES

There were many bright spots in the GDP report.

For one, household income after taxes and inflation increased at a strong 6.8 percent rate.

Along with a slower pace of inflation, that allowed households to step up their savings, and the saving rate rose by more than a percentage point.

An inflation gauge in the report advanced at just a 1.2 percent pace, down from 1.6 percent in the third quarter. So-called core prices rose just 0.9 percent, the smallest gain in two years.

Consumer spending, which accounts for more than two-thirds of economic activity, rose at a 2.2 percent rate, accelerating from the prior quarter's 1.6 percent growth pace, while business investment rebounded after its first drop in 1-1/2 years.

The housing market was another positive.

Residential construction grew at a 15.3 percent rate after notching a 13.5 percent growth pace in the third quarter. Homebuilding added to growth last year for the first time since 2005.

"A turnaround in the housing market will be a key support to the economy this year, with homebuilding contributing to growth and higher home prices supporting consumer spending," said Stuart Hoffman, chief economist at PNC Financial in Pittsburgh.

(Additional reporting by Leah Schnurr in New York; Editing by Andrea Ricci)

Source: http://news.yahoo.com/u-growth-seen-braking-inventories-government-weigh-060305476--sector.html

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