Thursday's weaker-than-expected advanced first-quarter GDP report indicates slower growth not only over the past three months, but most likely for the second quarter as well. Compounding concern among investors, inflationary pressures are also rising close to the top of the


comfort zone, as measured by the GDP's price deflator.

In other words, the Fed will likely feel compelled to maintain its "measured" tightening campaign, even as the economy slows. Stocks were lower midday Thursday in contemplation of such an outcome; the

Dow Jones Industrial Average

was recently down 0.4% to 10,158.30, the

S&P 500

was off 0.3% to 1152.88, and the

Nasdaq Composite

was down 0.4% to 1921.90.

Shares fell Thursday in reaction to the Commerce Department's report that the U.S. economy grew 3.1% in the first quarter, down from 3.8% in the fourth quarter of last year and below expectations for growth of 3.5%. While subject to revision, the 3.1% first-quarter GDP growth was the slowest in two years.

The biggest shockers came from capital spending, which rose only 6.9% compared with the 14.5% seen in the fourth quarter, and a faster-than-expected accumulation in inventories. Rising inventories made up about 1.2% of first-quarter growth; that means so-called real final demand -- GDP minus inventories -- was just 1.9%, observed

contributor Marc Chandler.

Moreover, the concern is that as businesses try to work down those inventories in the second quarter, they will produce less.

"With domestic production likely to decelerate in coming months, there is further downside risk to GDP growth in the second and third quarter 2005," says Bank of America senior economist Peter Kretzmer.

Consumer spending growth remained robust at 3.5% in the first quarter, but as energy costs are passed to more finished goods, spending is also expected to weaken in the second and third quarters. "A slowing to about 2.5% annualized consumption growth remains a central risk to economic growth in the next few quarters," Kretzmer says.

Unfortunately for markets hoping that a slowing economy would provide a break from the Fed's tightening, the key price component in the GDP, the core personal consumption expenditure price index, rose 2.2% for the quarter and 1.6% from last year.

That's "near the limits of the range that members of the FOMC have stated that they will tolerate," says analyst Daniel Jester.

Bank of America's Kretzmer also believes that with the Fed funds rate still at only 2.75%, nominal spending growth "will continue to motivate the Federal Reserve to normalize monetary policy."