US economy falls short of expectations in Q1

The first quarter saw the US economic recovery gather momentum but fall short of expectations with government cuts countering a sharp increasing in consumer spending.

US GDP was up at a 2.5 per cent annual rate between January and March, the Commerce Department said yesterday, as against forecasts by economists of 3 per cent growth.

The latest figure, which marked 15 consecutive quarters of growth was substantially higher than the 0.4 per cent GDP growth in the final quarter of 2012. However, the figures come with widespread budget cuts – known as sequestration, taking effect. The average pace of growth has remained a little over 2 per cent annually, which was weak by historical standards. The numbers follow disappointing news from the jobs market, which added only 88,000 new positions in March.

The biggest driver of growth was consumer spending in the first quarter. While personal consumption expenditures increased 3.2 per cent, the best pace since the end of 2010, durable goods sales including cars and household appliances increased 8.1 per cent.

Government cuts continued keep GDP back with federal government spending and investment declining 8.4 per cent in the quarter, after a 14.8 per cent fall in the last quarter of 2012. National defense was down 11.5 per cent as against a decrease of 22.1 per cent at the end of last year.

The increase in personal consumption comes as the  largest since the end of 2010.  However, analysts say this is probably unsustainable, as the Bureau of Economic Analysis (BEA) reported that real disposable personal incomes declined at an annualised rate of 5.3 per cent even as real spending was up at an annualised pace of 3.2 per cent.

The mismatch led the personal savings rate to fall from 4.7 per cent to 2.6 per cent.

According to analysts, consumption growth would not be able to continue at this pace without some combination of rising personal income and increased borrowing and at the moment, the outlook for both was negative. Incomes are already falling thanks to the tax hikes and spending cuts.

With households repaying but often defaulting on their debts for years, it was not clear why they would suddenly stop defaulting, especially given reasonable concerns about their future earning power.

Some like Federal Reserve chairman Ben Bernanke  would be given to thinking that rising house prices could lead to a "wealth effect" that would make people feel more comfortable borrowing and spending.

According to an important new essay by Amir Sufi, an economist at the University of Chicago, the "wealth effect" was always most potent among those with the worst credit and the least wealth outside of housing. For the most part, those people had lost their homes to foreclosure. They would not be in a position to buy new ones and would instead have to live in rental housing and rising house prices could force them to restrain consumption.