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U.S. Economy Slowed Sharply at End of 2005
U.S. Economy Slowed Sharply at End of 2005
By EDUARDO PORTER and VIKAS BAJAJ
Published: January 28, 2006
Economic growth weakened unexpectedly in the fourth quarter of 2005, rising 1.1 percent, the slowest pace in three years, and clouding the immediate outlook for the economy, the government reported yesterday.
Consumer spending slowed abruptly as purchases of motor vehicles collapsed after automakers phased out the generous incentive programs that had lifted sales through the summer. As consumers cut back on spending, business investment also slowed as companies curtailed spending on cars and trucks. Military spending also fell unexpectedly, while a surging import bill put a drag on overall growth.
The intensity of the economic slowdown, which reduced yearly growth to 3.5 percent from 4.2 percent in 2004, surprised many forecasters. They had expected a sharp pickup in business investment in the final months of the year to take up some of the slack in consumer spending and had predicted an overall growth rate of 2.5 percent to 3 percent in the fourth quarter.
"It is not so much surprising as baffling," said Ian C. Shepherdson, chief United States economist at High Frequency Economics in Valhalla, N.Y.
The weak economic data pleased investors, who pushed up the price of stocks in the expectation that the Federal Reserve, whose policy-making committee meets on Tuesday, might end its 18-month campaign to raise its benchmark interest rate ? now at 4.25 percent ? after it reaches 4.5 percent or 4.75 percent.
"The silver lining in this is that the Fed should look at this and realize that this economy is not overheating," said David Kelly, a senior economic adviser at Putnam Investments in Boston, the mutual fund manager.
Yet the abrupt slowdown fed into a bubbling debate over the nation's economic prospects as the housing market weakens and removes a core pillar supporting consumers' hearty spending.
Many economic analysts have been warning for months that the housing bubble will burst and lead to retrenchment as rising interest rates and the stalling of home sales put a dent in consumer spending.
"I believe it is a genuine slowdown," said Robert J. Barbera, chief economist at ITG, arguing that higher interest rates and expensive oil are taking the wind out of consumers' sails.
Specifically, he argued, the auto sector will keep bogging the economy down because car companies have built up heavy inventories that they must unload.
After setting records last summer, sales of existing homes, which make up 85 percent of the housing market, fell in each of the last three months as mortgage interest rates rose modestly.
New-home sales, a more volatile and less reliable indicator, increased 2.9 percent in December, to an annual pace of 1.27 million, after falling 9.2 percent in November, the Commerce Department said yesterday. Median prices, however, fell 3.4 percent, to $221,800 from a year ago.
Yet even though the housing market has started to cool, most forecasters argued that the fourth quarter's slowdown is not the beginning of a deeper slide. As they took stock of the data, economists argued that the economic slump would prove fleeting, caused by factors that are unlikely to be repeated in the first quarter.
Some warned that the reading for growth in the fourth quarter was merely a preliminary estimate and could be revised upward ? especially business investment, which should be surging at this stage in the economic cycle, when profits are high and companies are hitting capacity constraints. Most expected consumer spending and business investment to rebound in the first half of the year as the downturn in auto sales ends.
"The probability of a substantial upward revision is quite high," said Lincoln Anderson, chief investment officer at LPL Financial Services in Boston. "Then growth should rebound in the first quarter back into the region of 4 percent."
Much of the current slowdown could be attributed to Detroit. "It all boils down to the auto sector," said Daniel J. Meckstroth, chief economist for the Manufacturers Alliance/MAPI, a business research group. "Auto sales permeate everything in final demand."
Deep discounts on cars and trucks pumped sales by the three domestic automakers during the summer and early fall. But as the incentives expired and gasoline prices surged above $3 a gallon in some places in the aftermath of Hurricane Katrina, sales dropped precipitously.
In the fourth quarter of last year, final sales of motor vehicles fell 50.4 percent at an annual rate. Consumer spending on sport utility vehicles and other light trucks fell by 69 percent, at an annual rate, while business spending declined 19 percent. The effect on overall economic output was significant. Just the decline in consumer purchases of vehicles subtracted 2.06 percentage points from growth in the quarter.
Other items also contributed to the decline, but analysts argued they would prove temporary. Military spending slumped, a surprising development during a war.
"We are still trying to figure out where that came from," a Lehman Brothers economist, Joseph Abate, said.
Moreover, the surge in the price of oil led to a big jump in the nation's energy bill, contributing to a sharp rise in imports that put a drag on domestic output.
A buildup in business inventories provided a significant lift, 1.45 percentage points, to the economy. But if consumption remains weak, that additional stock of goods could force manufacturers to cut back on production in coming months.
"That's not sustainable growth," said Anthony Chan, chief economist at J. P. Morgan's private client services group.
Still, though economists believe that the economy will rebound in the immediate future, there remains a deep-rooted concern about a downturn further down the road.
Mr. Shepherdson, for instance, forecast a 30 percent to 40 percent drop in the number of home sales by the end of the year, which would put a freeze on consumer spending. Mr. Barbera predicted economic growth this year would fall to about 2.4 percent.
Charles Dumas, the chief international economist at forecasting firm Lombard Street Research in London, said in a note to investors: "It will take a miracle as fine as Mozart, 250 years old today and as fresh as new, to prevent a sharp U.S. slowdown in the second half of 2006, probably to nil growth" by the fourth quarter.
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