The US economy unexpectedly contracted in the first quarter amid a resurgence in COVID-19 cases and a drop in pandemic relief funds from the government, but the fall in production is confusing as domestic demand remains strong.
The first reduction in GDP in two years, reported by the Commerce Department on Thursday, was driven mostly by a broader trade deficit as imports increased, and a slowdown in the pace of inventory accumulation from the strong fourth quarter.
A measure of domestic demand that accelerated at the pace of the fourth quarter, allays fears of inflation or recession. The Federal Reserve is expected to raise interest rates by 50 basis points next Wednesday. The US central bank raised its policy interest rate by 25 basis points in March, and is likely to start reducing its asset holdings soon.
“The economy is still showing some resilience, but the first-quarter GDP report signals the start of more moderate growth this year and next,” said Sal Guatiri, a senior economist at BMO Capital Markets in Toronto. , “Despite the contraction, the Fed has no choice but to increase aggressively in May to control inflation.”
GDP fell at a 1.4% annual rate in the previous quarter, the government said in its advance GDP estimate. The economy grew at a strong 6.9% pace in the fourth quarter. Economists polled by Reuters had forecast the economy to grow at 1.1%. Estimates ranged from a rate of 1.4% contraction to a high of 2.6% growth.
In the last quarter, the economy was also hit by supply-chain challenges, labor shortages and rampant inflation. Nevertheless, production remains up 2.8% from its level in the fourth quarter of 2019. When measured on a year-over-year basis, the economy grew 3.6% in the first quarter.
Fears of shortages due to the Russo-Ukraine War led to an increase in imports amid front-loading by businesses. At the same time there has been a decline in exports. This sharply increased the trade deficit, which cut GDP growth by 3.2 percentage points. Business has been a drag on growth for seven consecutive quarters now.
With businesses turning to imports to meet demand, local manufacturers lack the ability to boost production. Although businesses continued to re-stock, momentum waned from the fourth quarter, resulting in a 0.84 percentage point cut from GDP growth in inventory investments.
US shares opened with gains. The dollar rose against a basket of currencies. US Treasury prices were mixed.
strong demand
Growth in consumer spending, which accounts for more than two-thirds of US economic activity, picked up at a 2.7% pace from the fourth quarter’s 2.5% pace, despite being hit by a winter wave of coronavirus cases, powered by Omicron type. Even as food and gasoline prices rise, consumers show no sign of backing down.
Strong wage benefits amid a tight labor market and at least $2 trillion in additional savings accumulated during the pandemic are providing a cushion against inflation. According to data from Bank of America Securities, lower-income consumers, who are disproportionately affected by inflation, were showing more resilience.
Tightening labor market conditions were reinforced Thursday by a separate report from the Labor Department, in which initial claims for state unemployment benefits fell by 5,000, a seasonally adjusted 180,000 for the week ended April.
Economists had predicted 180,000 applications for the latest week. Business investment accelerated as spending on equipment grew at a rate of 15.3% last quarter.
Combined with solid consumer spending to boost final sales by 3.7% to private home buyers. This measure of domestic demand, which does not include trade, inventory and government spending, grew at 2.7% in the fourth quarter. Final sales to private home buyers account for about 85% of the total expenses.
Still, concerns remain that the Fed could aggressively tighten monetary policy and propel the economy into recession over the next 18 months. The housing market is already showing signs of slowing down, with 30-year fixed mortgages shooting above 5%.
But much will depend on how quickly geopolitical tensions and supply chains ease and whether inflation subsides.