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US GDP Grows at 2.6% Pace as Business Spending Accelerates

Feb. 28, 2019
Equipment and software investment show bigger contributions.

The U.S. economy cooled by less than expected last quarter as business investment picked up, suggesting growth could be stronger for longer as the Federal Reserve takes a patient approach to interest rates.

The 2.6% annualized rate of gains in gross domestic product from October to December compared with the 2.2% median estimate of economists surveyed by Bloomberg. It followed a 3.4% advance in the prior three months, according to a Commerce Department report Thursday that was delayed a month by the government shutdown.

Consumption, which accounts for the majority of the economy, grew 2.8%, slightly below forecasts, while nonresidential business investment accelerated to a 6.2% gain on equipment, software and research spending. Government spending slowed, trade was a minor drag and inventories gave GDP a small boost.

Treasury yields and the dollar rose following the data.

The report shows how Republican-backed tax cuts may have continued to aid growth and help bring the full-year figure to 3.1%, just above President Donald Trump’s 3% goal. While the expansion is poised to become the nation’s longest on record at midyear amid a still-healthy consumer, supportive Fed and robust labor market, the pace could cool amid the trade war, slowing global growth and fading impact of fiscal stimulus.

The strength in overall private domestic demand “is good enough to keep the momentum in the economy going,” with research and development spending being a “bright spot” in the report, said Neil Dutta, head of economics at Renaissance Macro Research LLC.

A separate report Thursday from the Labor Department showed filings for unemployment benefits rose by more than expected last week to 225,000, still near a five-decade low. The week included the Presidents Day holiday, and claims tend to be more volatile around such events.

Potential Growth

Growth, while slower than the prior two quarters, remains above both the average pace of the expansion and what the Fed sees as the economy’s long-run potential of 1.9%. Still, surveys and gauges such as Treasury yields indicate chances of a recession have increased in recent months while remaining unlikely for 2019.

Excluding the volatile trade and inventories components of GDP, final sales to domestic purchasers increased at a 2.6% pace following 2.9%. Economists monitor this measure for a better sense of underlying demand.

What Our Economists Say...

The economy appears to have dodged a bullet at year-end -- but the coast is not clear ... Relative to history, the inventory accumulation in the second half of 2018 is large and threatens to overshadow production schedules (and manufacturing-related employment) in the first half of this year. Analysts should carefully scrutinize industrial surveys, such as the manufacturing ISM, for signs of a production lull intended to work off inventory excess. --  Carl Riccadonna,  Tim Mahedy and  Eliza Winger, Bloomberg Economics 

The increase in consumer spending followed the third quarter’s 3.5% gain. It contributed 1.92 percentage points to growth. Drivers included health care, financial services and insurance, and other nondurable goods and services, while spending on food services and accommodations fell.

The GDP data may reinforce analyst criticism of the government’s recent report on December retail sales. That showed the biggest drop in nine years, even as other figures -- particularly reports from the country’s largest retailers -- indicated consumers continued to open their wallets in the quarter.

Thursday’s report showed the third-quarter slowdown in business spending may have been temporary. Nonresidential fixed investment contributed 0.82 percentage point to growth following 0.35 point in the third quarter.

Within that category, spending on structures fell 4.2%, the biggest drop in a year, a slowdown that may partly reflect falling oil prices. Business-equipment investment rose 6.7% and intellectual property spending jumped 13.1%.

Residential Drag

Housing remained a weak spot last quarter, posting the fourth consecutive drag on GDP growth, with a contraction of 3.5%. Home sales tumbled in late 2018 amid elevated mortgage rates and price increases that continued to outpace wages, though there are signs of demand picking up in early 2019 thanks to a drop in borrowing costs.

Net exports subtracted 0.22 percentage point from GDP growth during the quarter following a 1.99-point reduction in the prior period. The drag reflected a 2.7% percent rise in imports that outpaced a 1.6% increase in exports, with the tariff war buffeting both sets of flows.

Inventories added 0.13 percentage point to the pace of expansion.

Meanwhile, inflation remained muted, adding little urgency for the Fed to consider resuming interest-rate hikes. The GDP report showed the Fed’s preferred price index rose at a 1.5% annualized pace last quarter, below the central bank’s 2% goal. Excluding food and energy, the index rose 1.7%.

Government spending increased at a 0.4% rate, reflecting a 6.9% jump in defense spending -- the most in nine years -- and a 5.6% contraction in non-defense spending, the biggest drop since 2013. The savings rate rose to 6.7% from 6.4% in the prior quarter, as inflation-adjusted disposable income rose 4.2%, the most in three quarters.

The partial shutdown, which began Dec. 22, had the effect of lowering fourth-quarter GDP growth by about 0.1 percentage point when accounting for the impact of reductions in services provided by the federal government, though the Commerce Department cautioned that the full effects of the shutdown on the economy can’t be quantified.

The first GDP estimate was originally scheduled for release Jan. 30. Thursday’s report encompasses both advance and second estimates. The revised estimate of fourth-quarter GDP is due March 28, data which will also include corporate profits for the period.

By Katia Dmitrieva

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