US Growth Improved in the Fourth Quarter, Fueled by an Inventory Bounce; Final Sales Were Disappointing

Fourth-quarter GDP growth came in at 2.8%, falling short of the consensus 3.0% rate, as we had anticipated. The mix of growth was not encouraging. A rebound in inventory accumulation added 1.9 percentage points to the growth rate. Firms became much more cautious in the third quarter, but when the worst fears over the consequences of the debt-ceiling debacle and S&P downgrade weren't realized, they rebuilt stocks in the fourth quarter. This is a "one-time" boost to growth—we won’t get the same inventory kick in the first quarter. The tricky question is how much of the fourth-quarter inventory accumulation was planned and how much unplanned—unwanted stocks (for example at those retailers where holiday sales disappointed) will be run down in the first quarter.

Final sales rose only 0.8%, although here there were a couple of drags that probably won't be repeated in the first quarter, as defense spending (down 12.5%) and oil and gas drilling (down 19.7%) both fell very sharply. The two combined took about 0.9 percentage point off the GDP growth rate.

The rest of the data pointed to a continued, but modest recovery. Consumer spending growth came in at 2.0%, a slower pace than expected, but even achieving that required a lower saving rate, since income growth was just 0.8%. We do expect income growth to do better in 2012, because of lower inflation and faster employment growth, but the 1.7% income growth that we anticipate wouldn't provide enough fuel for a sharp acceleration in consumer spending. We expect consumer spending growth of 2.2% in 2012.

Residential fixed investment achieved double-digit growth in the fourth quarter (10.9%), adding 0.2 percentage point to GDP growth. We have seen some improvement in housing starts (mostly multifamily), and we expect further gains in 2012, but housing activity is at such low levels that even sharp percentage gains don't add a lot to GDP growth.

Business equipment spending growth cooled down to 5.2%, after a spectacular third quarter (up 16.2%). Business construction spending appears to have been little changed in the fourth quarter, following strong increases in the second and third quarters. Business capital spending is likely to be an important driver of growth in 2012. Firms have plenty of funds available and will be seeking ways to upgrade their capital stock and boost productivity growth.

Export growth was steady, at 4.7%, but still much slower than we saw in the early stages of the recovery. With the Eurozone probably in recession and emerging-market growth slowing, export growth is likely to be slower in 2012 than in 2011. State and local government spending continued to drop (down 2.6%) and we expect further declines ahead.

Inflation was very quiet, with the GDP deflator up just 0.4% at an annual rate. The core personal consumption price index rose 1.1% annualized on the quarter and 1.7% year on year. Low inflation gives the Federal Reserve room for maneuver should it decide that the sluggish economy warrants another round of quantitative easing (as we expect it will).

The fourth-quarter GDP data don't show the recovery "taking off." It's consistent with continued, but gradual improvement. We expect growth of around 2% in the first quarter, and also around 2% for 2012 overall.

by Nigel Gault