Real GDP Growth Slows a Bit in Q1

Real GDP growth slowed in Q1. Growth in consumer spending was solid, but fixed investment spending was disappointing. We look for even slower growth in Q2.

Q1 GDP Growth a Bit Disappointing

Real GDP grew at an annualized pace of 2.2 percent in the first quarter, which represents the eleventh consecutive quarter that the economy has expanded (top chart). However, the outturn represents a step down from the 3.0 percent rate that was registered during the fourth quarter of last year, and it was below the 2.5 percent rate of the consensus forecast.

Let's start with the good news. Real personal consumption expenditures rose 2.9 percent, the strongest growth rate in this important category of expenditure in five quarters. This solid gain in consumer expenditure was driven by the 15.3 percent rise in spending on durable goods, the second consecutive quarter of double-digit growth in this category. Following a few years of weak auto sales, American consumers are beginning to show up in car showrooms again. However, growth in services spending continued to be weak, rising only 1.2 percent during the quarter, only half the pace that was averaged during the 2003-2007 expansion.

In contrast to strong growth in consumer spending, growth in fixed investment spending was weak, rising at just a 1.4 percent pace during the quarter. Strong growth in residential investment spending, which rose to a 19.1 percent rate, was largely offset by the 12.0 percent plunge in nonresidential construction. Business spending on equipment and software rose at only a 1.7 percent pace, the weakest growth rate since Q2-2009. In addition, government spending continued to exert headwinds on the economy, declining at a 3.0 percent rate in the first quarter. Government spending has now contracted for six consecutive quarters due, at least in part, to cutbacks at the state and local level and to declines in defense expenditures (middle chart).

An area of potential concern was the increase in inventories, which helped to boost the headline growth rate by 0.6 percentage points (bottom chart). Businesses may slow the pace of production if some of this inventory accumulation was unintentional. Indeed, recent indicators suggest that the pace of industrial production growth is slowing.

We look for the economy to downshift again as we forecast a sub-2 percent growth rate in the second quarter. Unlike last year at this time, when real GDP grew only 0.4 percent in Q1-2011 and 1.3 percent in Q2-2011, the economy is not stalling at present. However, most analysts would not characterize 2.2 percent growth as "robust" either. And with headwinds continuing to blow - slower growth in the rest of the world will affect exports and planned fiscal tightening will take effect later this year - we think that the economy will continue to grow at a sub-3 percent pace for the foreseeable future. The Fed may not undertake another round of QE anytime soon, but it surely won't be tightening policy either.