U-turn shrinks economy 0.1%

Defense cuts blamed; analysts say signs of growth still there

— The economy unexpectedly shifted into reverse in the fourth quarter as the biggest drop in defense spending in 40 years swamped gains for U.S. consumers and businesses.

The Commerce Department said the economy shrank at an annual rate of 0.1 percent mainly because companies restocked at a slower rate and because of defense spending cuts. Those trends partly reflected uncertainty late last year about tax increases tied to the federal budget, which Congress averted in a deal reached Jan. 1.

Economists say those factors could prove temporary, and the likelihood of another recession appears remote. Still, the sharp slowdown from the 3.1 percent annual growth rate in the July-September quarter, also drivenby a drop in U.S. exports, raised concerns about 2013.

“I’m not going to say growth is particularly strong, but this is not a recessionary signal by any means,” said Paul Edelstein, director of financial economics at IHS Global Insight in Lexington,Mass. “This really was a story about a payback in national defense spending. Consumer spending growth picked up, fixed investment was fairly strong.”

Congressional Republicans seem determined to permit deep cuts to defense and domestic programs to kick in as scheduled March 1. And Americans are coming to grips with an increase in Social Security taxes that has left them with less take-home pay.

Government spending cuts and slower company restocking, which can fluctuate sharply, subtracted a combined 2.6 percentage points from the gross domestic product, or GDP. Those two factors offset a 2.2 percent increase in consumer spending. And business spending on equipment and software rose after shrinking over the summer.

Stocks fell Wednesday, dragging benchmark indexes from five-year highs. The Standard & Poor’s 500 Index dropped 0.4 percent to 1,501.96 at the close in New York.

Wednesday’s report is the first of three estimates of GDP the government issues each quarter. GDP measures the nation’s total output of goods and services - from restaurant meals and haircuts to airplanes and appliances. The estimates of GDP are revised by an average of 1.3 percentage points between the first and third estimate. That means the final figure for the fourth quarter might end up showing either growth or a steeper contraction.

The Federal Reserve referred to the fourth-quarter slowdown in a statement after it ended a policy meeting Wednesday. The U.S. economy appears to have “paused in recent months,” the Fed said, mainly because of temporary factors.

For all of 2012, the economy expanded 2.2 percent, better than 2011’s growth of 1.8 percent. For 2013, analysts generally think the economy will grow at a steady if modest pace of roughly 2 percent as the housing and auto sectors continue to recover along with bank lending and consumer spending.

“Frankly, this is the bestlooking contraction in U.S. GDP you’ll ever see,” Paul Ashworth, an economist at Capital Economics, said in a research note. “The drag from defense spending and inventories is a one-off. The rest of the report is all encouraging.”

The plunge in defense spending in the October-December quarter came after a jump in the third quarter. The fluctuation might have reflected higher-than-usual spending that occurred in the July-September period in anticipation of government spending cuts later in the year. Some defense contractors reported lower government spending at the end of the year.

Last week, General Dynamics blamed a $2 billion fourth-quarter loss on “slowed defense spending.”

Exports fell by the most innearly four years, a result of Europe’s recession and slower growth in China.

Incomes, though, jumped last quarter as companies paid special dividends and bonuses ahead of expected tax increases in 2013. The Commerce Department estimated that businesses paid nearly $40 billion in early dividends. After-tax income, adjusted for inflation, rose 6.8 percent, the most in nearly four years.

Hurricane Sandy likely also dragged on growth by closing factories, disrupting shipping and shutting down retail stores. While the department did not specify Sandy’s effect on the GDP, it estimated that Sandy destroyed about $36 billion in private property and $8.6 billion in government property.

Top White House economist Alan Krueger said the storm, which battered the East Coast, disrupted economic activity and destroyed $44 billion in fixed capital.

Subpar economic growth has held back hiring. The economy has added about 150,000 jobs a month, on average, for the past two years. That’s barely enough to reduce the unemployment rate, which has been a still-high 7.8 percent for two months.

Economists forecast that unemployment stayed at that rate in January. The government will release the January jobs report Friday.

The slower growth in stockpiles occurred after a jump in the third quarter. Slower inventory growth means factories likely produced less. Heavy-equipment maker Caterpillar Inc. said this week, for example, that it reduced its inventories inthe fourth quarter as global sales declined from a year earlier.

Still, with consumer spending rising, companies might have to rebuild inventories in the January-March quarter, economists say. That could spur growth.

A big question for 2013 is how consumers will react to the expiration of the Social Security tax cut. Congress and the White House allowed the temporary tax cut to expire in January but prevented income taxes from rising for most Americans.

The Social Security tax increase will reduce takehome pay this year by about 2 percent. A household earning $50,000 a year will have about $1,000 less to spend. A household with two high-paid workers will have up to $4,500 less.

A key measure of consumer confidence plummeted this month after Americans noticed the reduction in their paychecks, the Conference Board reported Tuesday.

Several trends, though, are expected to help growth later this year.

Homebuilders are stepping up construction to meet rising demand. That should create more construction jobs.

And home prices are rising steadily. That tends to make Americans feel wealthier and more likely to spend. Housing could add as much as 1 percentage point to economic growth this year.

Information for this article was contributed by Christopher S. Rugaber, Andrew Taylor and Robert Burns of The Associated Press and by Shobhana Chandra and Michelle Jamrisko of Bloomberg News.

Front Section, Pages 1 on 01/31/2013

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