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Economy Grew 1.3% in First Quarter, Much Slower Than Expected

Weaker exports and a steady slide in spending on homebuilding helped slow U.S. economic growth to its softest pace in four years during the first quarter, the Commerce Department reported on Friday.

Gross domestic product or GDP, which measures total goods and services output within U.S. borders, increased at a weaker-than-expected 1.3% annual rate in the three months from January through March.

That was a little more than half the fourth quarter's 2.5% rate and well below the 1.8% rate that Wall Street analysts had forecast GDP would expand. The last quarter when growth was weaker was in the first three months of 2003, when GDP expanded at a 1.2% rate.

“It’s a bad report that’s not quite as bad inside as the top line might suggest,” CNBC’s Steve Lieman said.

He said consumer spending was stronger than expected. Spending on equipment and software rose 1.9% and most analysts expected a negative number.

Federal Spending Slows

Liesman said government spending rose only 0.9% while most expected a 2% increase.
Inventories were up 14%.

“If you want a culprit, 0.3% of the miss was likely the result of lower-than-expected inventory builds,” Liesman said. “But that might have been good because we knew we had an inventory problem to work out – and maybe they worked it out a little faster.”

He said core inflation was the big surprise.

“The higher-than expected inflation number is one big reason economists missed on their forecasts,” Liesman said. “But the economy’s top line came in at 5.3% -- that’s actually an acceleration of nominal GDP growth from the prior quarter. So, yes, inflation is a little bit higher, but inside several sectors are doing pretty well and the ones that are doing bad are the ones that we knew were doing poorly.”

Meanwhile, Edward Lazear, chairman of the President’s Council of Economic Advisers, told CNBC’s “Squawk on the Street” that the job market remains strong, suggesting economic strength and higher growth ahead.

“The most important indicator to me is the labor market,” Lazear said. “It’s very strong. If the labor market were weak, if we were seeing job growth slow down, if we saw wage growth slow down, then I would be a bit more concerned about the GDP number.”

Housing Big Factor

Growth has been slowing since late last year under the impact of a hard-hit housing sector where rising defaults are taking a toll on the subprime lending sector and causing builders to scale back until inventories of completed but unsold homes are reduced.

Residential spending shrank by 17% in the first quarter following declines of 19.8% in the fourth quarter and 18.7% in the third quarter last year. It was the sixth straight quarter in which spending on residential construction contracted.

"With this figure on GDP there is going to be less emphasis on the Fed to increase rates, but there is less room for them to cut them, either," said Subodh Kumar, a chief investment strategist at Subodh Kumar & Associates.

The Federal Reserve hasn't moved a key interest rate since August. Before that it had steadily lifted rates to ward off inflation. Many economists predict the Fed will continue to leave rates alone when it meets next month. The Fed's goal is to slow the economy sufficiently to key inflation in check, but not so much as to provoke a recession.

But even as economic growth slowed in the latest period, inflation picked up. This trend, if it continues will complicate the Fed's work.

Price Gauge Higher

A price gauge favored by the Federal Reserve - personal consumption expenditures excluding food and energy items - increased at a 2.2% rate in the first quarter, slightly ahead of forecasts for a 2.1% advance. That was up substantially from the fourth quarter's 1.8% rate and is likely to keep Fed policy-makers wary about the potential for a pickup in inflation.

Companies showed some wariness about building up large inventories. Spending on inventories increased at a $14.8-billion rate in the first quarter, well down from the fourth quarter's $22.4 billion. It was the weakest pace of inventory addition since the third quarter of 2005, when companies drew them down at a $12.2-billion rate.

Many economists say growth may regain some strength later in the year, once the worst of the slowdown in the housing sector has passed. The GDP report showed consumers increased spending in the first quarter at a 3.8% annual rate, down modestly from the 4.2% rate in the fourth quarter but a significant reservoir of strength since consumer spending accounts for the about two-thirds of national economic activity.

Business investment showed some signs of resilience, with spending up at a 2% rate in the first quarter, partly recovering from a 3.1% decline in the closing quarter of 2006.

Exports declined at a 1.2% rate in the first quarter, a sharp reversal from the fourth quarter's 10.6% advance. It was the first decline in exports since the second quarter of 2003 when they fell at a 1.7% rate.