Imports hold back US economy in first quarter, inflation flares up

By Lucia Mutikani

WASHINGTON (Reuters) - The U.S. economy grew at its slowest pace in nearly two years in the first quarter amid a surge in imports and small build-up of unsold goods at businesses, signs of solid demand that together with an acceleration in inflation reinforced expectations the Federal Reserve would not cut interest rates before September.

The cooler-than-expected growth reported by the Commerce Department in its snapshot of first-quarter gross domestic product on Thursday, which also reflected a downshift in government spending, exaggerated the moderation in economic activity. Domestic demand, a better growth measure, was strong as consumer spending moderated slightly while business investment picked up and the housing recovery gained steam.

Trade and inventories are the most volatile GDP components, and are often subject to revision when the government updates its growth estimates. Fed officials are expected to leave rates unchanged at the U.S. central bank's policy meeting next week.

"The Fed will likely see the GDP report as solid, while the upward surprise to inflation will support the central bank's case for waiting longer before cutting rates," said Daniel Vernazza, chief international economist at UniCredit.

GDP increased at a 1.6% annualized rate last quarter, the slowest pace since the second quarter of 2022, the Commerce Department's Bureau of Economic Analysis said. Economists polled by Reuters had forecast GDP would rise at a 2.4% rate, with estimates ranging from a 1.0% pace to a 3.1% rate.

The economy grew at a 3.4% rate in the fourth quarter. The first-quarter growth pace was below what U.S. central bank officials regard as the non-inflationary growth rate of 1.8%.

Excluding inventories, government spending and trade, the economy grew at a 3.1% rate after expanding at a 3.3% rate in the fourth quarter. That also dispels the notion that government spending was fueling the economy.

The U.S. economy, which has outperformed the economies of other advanced nations, is being supported by a resilient labor market.

U.S. Treasury Secretary Janet Yellen told Reuters in an interview that she was focused on consumer and business spending.

"Those two elements of final demand came in line with last year's growth rate ... so this is the underlying strength of the U.S. economy that showed continuing robust strength and an economy firing on all cylinders."

Price pressures heated up by the most in a year, with a measure of inflation in the economy increasing at a 3.1% rate after rising at a 1.9% pace in the October-December quarter.

The personal consumption expenditures (PCE) price index excluding food and energy surged at a 3.7% rate after increasing at a 2.0% pace in the fourth quarter.

The so-called core PCE price index is one of the inflation measures tracked by the Fed for its 2% target. Inflation was boosted by increases in the costs of services like, transportation, insurance and housing, which offset a decline in goods prices such as motor vehicles and parts.

The strong readings pose an upside risk to March PCE inflation data due to be released on Friday, though much would depend on revisions to the January and February data.

The Fed has kept its benchmark overnight interest rate in the 5.25%-5.50% range since July. It has raised the policy rate by 525 basis points since March of 2022.

Stocks on Wall Street were trading lower. The dollar slipped against a basket of currencies. U.S. Treasury yields rose.

TIGHT LABOR MARKET

A significant slowdown in the labor market is not yet evident. The Labor Department's weekly jobless claims report showed initial claims for unemployment benefits fell 5,000 to a seasonally adjusted 207,000 in the week ending April 20.

The number of people receiving benefits after an initial week of aid, a proxy for hiring, declined 15,000 to 1.781 million during the week ending April 13. The so-called continuing claims data covered the period during which the government surveyed households for April's unemployment rate.

Continuing claims fell between the March and April survey periods, implying the unemployment rate was likely unchanged after dipping to 3.8% last month from 3.9% in February.

Low layoffs are keeping wages high, sustaining consumer spending, which accounts for more than two-thirds of economic activity. Consumer spending grew at a still-solid 2.5% rate, slowing from the 3.3% growth pace rate notched in the October-December quarter. Spending was driven by healthcare, financial services and insurance, which more than offset a decline in goods, including motor vehicles and gasoline.

Spending is likely to gradually cool this year. Lower-income households have depleted their COVID-19 pandemic savings and are largely relying on debt to fund purchases. Recent data and comments from bank executives indicated that lower-income borrowers were increasingly struggling to keep up with their loan payments.

Though income increased at a $407.1 billion rate compared with the fourth quarter's $230.2 billion pace, the gains were eroded by inflation and higher taxes. Income at the disposal of households after accounting for inflation and taxes rose at a 1.1% rate versus a 2.0% pace in the October-December quarter.

The saving rate decreased to 3.6% from 4.0% in the prior quarter.

"The recent stickiness in inflation lends downside risk to the near-term forecast for consumption as it could weigh on real disposable income," said Ryan Sweet, chief economist at Oxford Economics.

Inventories were whittled down, rising at a $35.4 billion rate after increasing at a $54.9 billion pace in the fourth quarter. Inventories subtracted 0.35 percentage point from GDP growth. Part of the spending was satiated with imports, which resulted in the trade deficit widening to $973.2 billion from $918.5 billion in the October-December quarter. Trade chopped off 0.86 percentage point from GDP growth.

Government spending decelerated to a 1.2% rate from the 4.6% pace notched in the October-December quarter amid a decline in federal government outlays, mostly defense. Business spending picked up as companies invested in artificial intelligence.

Investment in nonresidential structures like factories contracted for the first time in more than year as the boost from policies by the Biden administration to bring the production of semiconductor manufacturing back to the U.S. faded.

Residential investment recorded its fastest pace of growth since the fourth quarter of 2020, thanks to rising home sales and housing construction, despite higher mortgage rates.

"Don't underestimate this economy," said Shannon Grein, an economist at Well Fargo.

(Reporting by Lucia Mutikani; additional reporting by Alessandra Galloni; Editing by Chizu Nomiyama, Andrea Ricci and Paul Simao)