US economy contracts for the first time in 3-1/2 years
A woman look at shoes on a display sale in New York, January 28, 2013.
The U.S. economy stopped dead in its tracks in the last three months of 2012 as the halting recovery was slammed by the biggest cut in defense spending in 40 years, fewer exports and sluggish growth in company stockpiles.
The slowdown has provoked worries that the fiscal cliff standoff in Washington at the end of the year took a larger-than-expected bite out of economic activity in the fourth quarter and would continue to pressure businesses and consumers in the new year.
The Commerce Department said Wednesday the economy contracted at an annual rate of 0.1 percent in the fourth quarter. That's a sharp slowdown from the 3.1 percent growth rate in the July-September quarter.
It was the economy's first decline sine the 2007-2009 recession and the worst performance since the second quarter of 2009.
The surprise contraction could raise fears about the economy's ability to handle tax increases that took effect in January and looming spending cuts.
The weakness may be because of one-time factors, though. Government spending cuts and slower inventory growth subtracted a total of 2.6 percentage points from growth. Both are volatile. And they offset faster growth in consumer spending, business investment and housing.
The contraction, coming against a backdrop of tightening fiscal policy, could spur fears of a new recession and create an urgency for policymakers to deal with outstanding budget issues.
Economists polled by Reuters had expected output to increase at a 1.1 percent rate.
None of the economists surveyed had predicted a contraction.
A pick-up in consumer spending and a rebound in business investment, however, curbed the slide in output and offered some hope for the recovery, which will be severely tested as Washington tightens its belt.
The biggest question going forward is how consumers react to the expiration of a Social Security tax cut. Congress and the White House allowed the temporary tax cut to expire in January, but reached a deal to keep income taxes from rising on most Americans.
The tax increase will lower take home pay this year by about 2 percent. That means a household earning $50,000 a year will have about $1,000 less to spend. A household with two high-paid workers will have up to $4,500 less.
Already, a key measure of consumer confidence plummeted this month after Americans noticed the reduction in their paychecks, the Conference Board reported Tuesday.
The GDP data was published as officials at the Federal Reserve wrap-up a two-day meeting. The report will likely provide ammunition for officials at the U.S. central bank to stay on their ultra-accommodative policy stance.
Economists say a growth pace in excess of 3 percent would be needed over a sustained period to significantly lower high unemployment. The economy has struggled to hold above a 2 percent growth pace.
For the whole of 2012 the economy grew 2.2 percent.
The economy was slammed by a monster storm in late October, which caused extensive damage along the East Coast, which was expected to have cut around 0.5 percentage point off fourth-quarter growth.
Businesses, caught with too much inventory in their warehouses in the third quarter, slowed their stock building in the final three months of the year.
That slowdown sliced 1.27 percentage points from fourth-quarter GDP growth. That was the biggest drag in two years. Excluding inventories, the economy grew at a 1.1 percent rate, slowing from the third quarter's 2.4 percent.
Government spending tumbled at a 6.6 percent rate, as defense outlays plunged at a 22.2 percent pace, wiping out the previous quarter's gains. Government subtracted 1.33 percentage points form growth. The decline in defense spending was the largest since 1972.
Export weakness also weighed on growth. Exports have been hampered by a recession in Europe, a cooling Chinese economy and storm and strike-related port disruptions. Overall trade cut a quarter of a percentage point from GDP growth. Exports fell for the first time since the first quarter of 2009.
Not all the details in the report were bleak.
Importantly, consumer and business spending showed some strength, and income available to households after taxes and inflation increased substantially in the fourth quarter.
Consumer spending, which accounts for more than two-thirds of economic activity, rose at a 2.2 percent rate, accelerating from the prior quarter's 1.6 percent growth pace.
Business investment rebounded after its first drop in 1-1/2 years in the prior quarter. The housing market was another bright spot. Residential construction grew at a 15.3 percent rate after notching a 13.5 percent growth pace in the third quarter.
Homebuilding added to growth last year for the first time since 2005.
The Associated Press andReuterscontributed to this report.