Updated from 9:48 a.m. EST

War abroad and cheap auto financing at home combined to create a slight increase in fourth-quarter gross domestic product, the government said in a preliminary report.

The unexpected 0.2% increase confounded economists' prediction of up to a 1.1% contraction in the quarter and made it increasingly likely that at least one definition of recession -- two consecutive quarters of GDP contraction -- would not be met in the current downturn.

According to the Commerce Department, businesses slashed inventories by a record $120.6 billion annual rate in the final quarter of 2001, breaking the previous record of $61.9 billion cut in the previous three months. But that reduction, which is a drag on GDP, was offset by a 5.4% increase in consumer spending, the biggest increase since the first quarter of 2000. Real final sales, which exclude inventories, rose at a 2.5% annual pace in the fourth quarter.

"The surprise was a totally mysterious surge in consumption," said Anthony Karydakis, senior financial economist at Banc One Capital Markets. "That 5.4% annualized growth in consumption is very hard to explain based on monthly spending data. The other thing that caught everyone's eye was that massive inventory liquidation, which is good news for the economy," said Karydakis.

The consumer spending numbers were goosed by the buying frenzy attending the auto industry's interest-free financing incentives at the end of 2001. Durable-goods spending, which includes cars and trucks, in the fourth quarter was at its highest rate of any time in the last 15 years.

While monthly retail sales data usually correspond closely with GDP consumer spending figures, the monthly data is highly revisable -- December's sales will be updated several more times -- and imported auto sales are not taken into account.

Government spending rose at a 9.2% annual pace in the fourth quarter, as the war in Afghanistan pushed up military spending by 9.3%, almost three times as fast as in the prior three months. Non-defense and state and local government spending also increased.

Spending on new equipment by companies continued to sag, albeit at a slower rate. Business investment in equipment and software dropped at a 5.2% annual rate, compared with an 8.8% pace of decline in the third quarter. Exports dropped 12.4%, while imports fell 3.4%.

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The government emphasized that the fourth-quarter "advance" estimate is subject to further revision, and that the more comprehensive "preliminary" estimates will be released on Feb. 28.

On the Horizon

Karydakis expects the surge in consumer spending won't carry over into the first quarter, but says the drag from inventories and trade probably won't either. He forecasts 1% or so positive growth in the first quarter, leading to faster growth during the rest of 2002.

The danger is that consumer spending falls off a cliff, as business spending continues to decline, which would deter companies from rebuilding inventories and throw a wrench into the spring recovery scenario. That is what

Federal Reserve Chairman Alan Greenspan remains concerned about, economists said.

"Greenspan is cognizant of the fact that some of that

strong consumer spending is due to auto sector and retailer discounts, the mortgage refinancing boom, falling gasoline prices and tax rebates, all of which are fading from the scene," said Bruce Kasman, chief U.S. economist at J.P. Morgan Chase. "One question on his mind is how much will consumer spending slow from that pace. It could get quite weak, and inhibit a recovery quite a bit."

Weekly jobless claims and consumer confidence numbers suggest the consumer ought to be in pretty good shape. After peaking at 506,250 in mid-October, the four-week average dropped to 404,250 in the week ended Jan. 19, the last report on record. Consumer confidence has risen to 97.3 in January from 85.3 in October.

It's also encouraging that auto sales, the primary driver of fourth quarter consumer spending, have held up better than most people expected so far this month. But January sales, forecast to come in at 15 million and 16 million units in annualized terms, are well below record October levels of 21.3 million. Meanwhile, the weaker sales levels continue to be supported by discounting. Automakers have mostly withdrawn their zero-percent financing offers, with cash rebates taking their place.

"All of the surprise

in consumer spending came from durables, so we should get a negative payback in the first quarter there," said Peter Hooper, chief U.S. economist at Deutsche Bank. "The incentives are still there, and will have to come off at some point as profits are suffering," he said.