Greg Ip's Saturday morning story for the Wall Street Journal:
WSJ.com - Economic Growth Slowed to 1.1% In Fourth Quarter : GDP Is Likely to Rebound, But Many Say Expansion Will Moderate This Year By GREG IP Staff Reporter of THE WALL STREET JOURNAL January 28, 2006; Page A1: Economic growth slowed to its most sluggish pace in three years at the end of last year as consumers and businesses applied the brakes to spending. While a rebound is likely in the current quarter, the expansion after two brisk years appears to be moderating as higher energy prices and interest rates begin to bite.
The nation's gross domestic product, or total output of goods and services, grew at just a 1.1% annual rate in the fourth quarter, the Commerce Department said Friday. That's the slowest rate since the fourth quarter of 2002 and well below the average 4.1% growth of the prior 10 quarters. "There is a slight tone change in the economy, though nowhere nearly as dramatic as the headline suggests," said Nancy Lazar, economist at ISI Group, a New York research and brokerage firm. "Growth may be moving into a slower stage."
The principal cause was a slowdown in growth of consumer spending to a four-year low of 1.1%. Other sectors softened, too. Business investment grew just 2.8%, less than a third of the prevailing rate in the prior 2½ years. Residential housing construction grew 3.5%, the slowest pace in a year. And the trade deficit widened sharply, damping domestic production. Federal defense spending dropped, too.
Economists pointed to four factors in the slowdown that are likely to reverse in the current quarter. The trade deficit widened in part because Hurricane Katrina idled a lot of Gulf of Mexico energy production, forcing the U.S. to rely more on imports. Gulf production is slowly recovering. Ms. Lazar said the trade deficit probably won't widen as much in the current quarter. Consumer spending growth slowed during the quarter mostly because of weak automobile sales. But Citigroup economist Steve Wieting noted that auto sales have since leveled off.
Several months ago, A.G. Lafley, chief executive at Procter & Gamble Co., said the big consumer-products maker was "nervous as cats" about consumers in the wake of two hurricanes and higher energy prices, and was closely tracking the frequency of consumer shopping trips and the amount spent. But on Friday, as P&G reported a 29% jump in quarterly profit, he told analysts that he is now less worried. "We are with the consumer every day," he said. "So far, so good." (See related article.) Federal defense outlays fell because of the late signing of the defense appropriations bill, and Pentagon spending will likely rebound, Mr. Wieting, the Citigroup economist, said. Lastly, business investment was held back by a drop in transportation-equipment purchases. David Rosenberg, economist at Merrill Lynch, said shipment data from Boeing Co. suggest capital spending ought to look stronger in the current quarter.
For all these reasons, economists said growth will probably recover in the first quarter. Indeed, initial claims for unemployment insurance have been trending lower, leading some analysts to predict that job growth will top a hefty 250,000 in January. The government releases its estimate of January job growth on Friday. Yet the U.S. may be settling into a period of growth that is slower than in the past couple of years -- not unusual for an economy four years into an expansion. To absorb last year's jump in natural gas and gasoline prices, consumers may have to restrain other spending. The Federal Reserve's steady increases in short-term interest rates may finally be having an effect on borrowing and spending. Auto makers are more reluctant to offer cut-rate financing. And while long-term mortgage rates haven't risen in the past two years, increasingly popular adjustable-rate mortgages, tied to short-term rates, have.
Stocks rose sharply Friday as several bullish profit reports outweighed the weaker than expected GDP report. The Dow Jones Industrial Average rose 97.74 points to 10907.21. Bonds were little changed. The GDP report also found that inflation crept up. The price index of consumer expenditures, excluding food and energy, the Fed's preferred inflation measure, advanced at a 2.2% annual rate, up from 1.4% in the third quarter, putting it around the top of incoming Fed chairman Ben Bernanke's comfort zone of 1% to 2%. The Fed is expected to raise its target for short-term interest rate to 4.5% on Tuesday from 4.25%. Markets and economists are divided on whether it will raise the rate again on March 28 to 4.75%. "The Fed might pause after the January meeting to assess whether the fourth-quarter weakness is the beginning of a more protracted slowdown and if the rise in inflation is more than temporary," said Nariman Behravesh, chief economist at Global Insight, an economic analysis firm.
The Commerce Department also said Friday that sales of new homes rose 2.9% in December from November, to an annual rate of 1.27 million, failing to recoup November's 9.2% drop. The inventory of unsold homes stood at 516,000, or 4.9 months' supply. That ratio is unchanged from November and still the highest since 1996. The median sale price, at $221,800, was down 3% from a year earlier. However, Michael Carliner, economist at the National Association of Home Builders, said changes in the way data are collected have understated price gains. Mr. Carliner predicted that home sales will drop 6% this year, and residential construction, a big engine of growth for several years, will become a drag. But he said that unless mortgage rates jump sharply, a severe downturn is unlikely. He said that while the number of new homes for sale has risen, the share that haven't yet been built has grown, to 21% of total housing inventory in December from 16% a year earlier. That reduces the potential impact on construction of a fall in sales.
Mr. Rosenberg said the impact of a housing slowdown will spread beyond just home building and real-estate commissions as consumers, who have been borrowing against the rising home values, spend less and save more. "The principal reason the saving rate is negative is all the borrowing that took place against an ever-rising home price, and that's coming to an end," he said. That will be partly offset by healthy growth in business-equipment spending and exports, he predicted.
Consumers did spend more than they earned in the fourth quarter, producing a negative saving rate for the third consecutive quarter and a negative rate for the year as a whole for the first time since 1947, when records of such data began. But the rate improved in the fourth quarter to minus 0.4%, from minus 1.8% in the third quarter.