Consumer Spending Props Up GDP

The Commerce Department reported that the U.S. economy slowed to a seasonally adjusted annualized real growth rate of just 1.3 percent in the first quarter of 2007.

Following a fourth quarter rise of 2.5 percent, this marks the slowest rate of growth in four years, largely a result of a slumping housing market and rising inflation. With the robust 5.6 percent GDP (Gross Domestic Product) increase from one year ago now removed from the year-over-year total, growth for the last twelve months now stands at an anemic 2.1 percent.

This "advance" estimate is the initial look at first quarter GDP. It will be followed by the "preliminary" estimate at the end of May and the "final" reading two months from now.

Revisions to previous advance estimates have been significant but it is unlikely that upward revisions to such a low figure will be able to somehow turn this into a positive result - the combination of rising consumer prices (used to adjust nominal GDP downward) and the housing slowdown were just too great during the first three months of the year.

Inflation, housing, and spending
Inflation rose sharply, the PCE (personal consumption expenditures) index posting a 4.0 percent increase after rising only 1.7 percent in the fourth quarter. The core rate, excluding food and energy, rose from 1.8 percent to 2.2 percent.

Rising oil prices during the first quarter led to a higher trade deficit that also affected the bottom line. Real GDP fell 0.5 percentage points as a result of imports rising 2.3 percent while exports declined 1.2 percent.

During the fourth quarter, a narrowing trade gap added 1.6 percentage points to GDP, continuing evidence of the importance of oil prices on this report and many other economic reports.

Residential fixed investment has now declined for six consecutive quarters, the most recent setback of 17.0 percent reducing GDP by almost a full percentage point. The housing slump first became a drag on economic growth in the fourth quarter of 2005 with a 0.9 percent drop.

During 2006, residential fixed investment declined 0.3 percent, 11.1 percent, 18.7 percent, and 19.8 percent, and given that there is no end in sight for homebuilders, this trend is likely to continue well into the 2007.

Consumers continued to spend as durable goods purchases rose 7.3 percent leading to an overall increase of 3.8 percent in personal consumption expenditures. Consumption contributed 2.66 percent to overall GDP whereas private investment took away 1.06 percent, primarily a result of the housing slowdown.

The most astonishing part of this entire report is that personal consumption now accounts for 72 percent of gross domestic product, up from 71 percent during all of 2006 (using chained dollars).

With just a marginal pullback in spending, this would have been a much worse report - a sign that the American consumer continues undaunted and is now supporting economic growth more than ever before, this point demonstrated clearly in the chart below.

If and when consumption slows, there will be a dramatic impact on GDP.