(Bloomberg) — U.S. economic growth fell to a nearly two-year low in the final quarter while inflation rose to uncomfortable levels, interrupting a run of strong demand and subdued price pressures that had fueled optimism for a soft landing.
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Gross domestic product rose 1.6% on an annual basis, below all economists’ forecasts, according to the government’s first estimate. The economy’s most important growth engine – private spending – rose slower than expected at 2.5%. A larger trade deficit detracted from growth by the most since 2022.
A closely watched measure of underlying inflation rose a more-than-expected 3.7%, the first quarterly acceleration in a year, the Bureau of Economic Analysis report showed on Thursday.
The numbers represent a noticeable loss of momentum at the start of 2024 after the economy wrapped up a surprisingly strong year. As inflation rises, Federal Reserve policymakers, who were already expected to keep interest rates at two-decade highs at their meeting next week, could come under renewed pressure to further delay any rate cuts and even think about whether the borrowing costs are high enough.
Treasury bonds fell and the S&P 500 opened lower, with traders pushing back the expected timing of the Fed’s first rate cut to later this year.
Read more: The Fed resets the timing of rate cuts and questions whether rates are high enough
“Hot inflation is the real story in this report,” Olu Sonola, head of U.S. economic research at Fitch Ratings, said in a note. “If growth continues to slowly slow but inflation starts to rise sharply in the wrong direction again, the expectation of a Fed rate cut in 2024 becomes increasingly out of reach.”
The rise in inflation in the first quarter was driven by a 5.1% rise in services inflation (excluding housing and energy), which was almost twice as fast as in the previous quarter. March figures on inflation, consumer spending and income are expected on Friday.
For the first time in two years, government spending fell from GDP. Corporate inventories fell for the second quarter in a row.
Excluding inventories, government spending and trade, inflation-adjusted final sales to private domestic buyers – a key indicator of underlying demand – rose 3.1%.
The GDP report showed that spending on services rose the most since the third quarter of 2021, driven by healthcare and financial services. Spending on goods fell for the first time in more than a year, held back by automobiles and gasoline.
Housing investment rose at an annual rate of nearly 14%, the fastest since the end of 2020, underscoring builders’ efforts to increase inventory.
What Bloomberg Economics says…
“The economy continued to grow at an above-trend pace excluding volatile categories. Additionally, strong imports are an indication of continued solid demand, which is not what the Fed wants.”
— Eliza Winger, economist
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At next week’s Fed meeting, traders will scour Chairman Jerome Powell’s comments for clues to the latest thinking on monetary easing. He has previously said growth can move faster without fueling inflation thanks to supply-side improvements such as immigration, which increases the workforce.
Separate data released Thursday showed initial jobless claims fell to 207,000 last week, the lowest level in two months. Permanent claims also fell.
The GDP and inflation numbers pose another hurdle for President Joe Biden, who has tried to convince Americans that he has done a good job on the economy. Consumer sentiment has trended sideways in recent months, and voters in key swing states are pessimistic about the outlook.
– With support from Chris Middleton and Augusta Saraiva.
(Adds residential investments)
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