GDP Rose More Than Expected in Q1

(Updated from 8:34 a.m. EDT)

By all accounts it was a lackluster first quarter for the U.S. economy, although it turned out a bit better than expected. Gross domestic product grew 2% in the first quarter, hampered by another sharp decline in business investment.

However, the economy grew more than it did in the fourth quarter, owing to increases in consumer spending on durable goods, an upturn in housing and an unexpected narrowing in the trade deficit. The consensus expectation among economists had been for growth of just 1.1%. This is the advance figure for GDP; the report will be revised two more times.

This report certainly turned out better than expected, but it's not a strong report, and in some ways, the strength of the headline number is misleading. For one, the improving trade deficit is a positive for this report not because growth in exports was stellar, but because imports are falling at a greater rate than exports.

It's clear from this release that consumer spending, which accounts for 68% of the nation's economy, is straining to pull the rest of the economy with it. Consumer spending added 2.11 percentage points to GDP in this quarter, which means the combined total of the rest of the components dragged on the economy.

There are some positive signs from this report, such as the rebound in housing and consumer spending on durable goods. But the economy still sits on a sharp edge. It's too early to tell whether the signs of a rebound in the economy will be sustained when viewed against the weakening labor market and the decline in corporate profits. But at this point the economy isn't sinking either, and it should see some kind of benefit from the recent efforts of the Federal Reserve to cut interest rates.

Consumer spending on durable goods -- one of three key engines of economic growth -- strengthened in the first quarter. Spending on items like appliances and autos meant to last longer than three years rose 11.9% in the first quarter after falling in the fourth quarter of last year. That's a positive because it should translate into the need for more production from companies. Housing rebounded as well, rising 3.3% after two straight quarters of decline.

Investment in equipment and software is still on the weak side, falling 2.1% after declining in the fourth quarter. Economists believe equipment and software spending, owing to the glut of capacity companies already have available to them, is likely to drag on the economy for a few more quarters. Overall business investment rose just 1.1%, mostly due to investment in structures.

Inventories, meanwhile, fell $7.1 billion, the first decline in inventories since the third quarter of 1991. These are being watched closely since so many big-name tech companies have complained of excess goods in their warehouses. Some companies have been successful reducing inventories. Companies are more likely to increase production the faster they can work down their inventories.

This is the second straight quarter of mediocre economic growth, following the fourth quarter's 1% growth rate. Because the report was stronger than anticipated, stock futures rose after its release.

The economy has slowed rapidly in the span of just three quarters -- it grew 5.6% in the second quarter of 2000. Higher interest rates, declining business demand for equipment and software and falling equities ate into economic growth in the last several months. The Federal Reserve started a series of interest rate cuts at the beginning of the year to put life back into the economy.

This report's inflation component, the implicit price deflator, rose 3.2%, compared with a 2% increase in the fourth quarter. Economists polled by Reuters were expecting a rate of 2.8%. The figure, the strongest reading since the first quarter of 2000, shows inflation isn't dead, despite the decline in economic growth.