NEW YORK: Analysts have been stumped by the apparent resilience of the U.S. economy, which seemed to be bounding ahead at a 3.5 percent pace in the final quarter of last year even as the housing market fell and the Federal Reserve raised interest rates.

The paradox has been solved: The economy was not bounding. The Commerce Department reported Wednesday that economic growth inched ahead by 2.2 percent in the fourth quarter of last year, only slightly faster than the 2 percent growth recorded in the third quarter and far below the economy’s long-term trend rate of growth.

The downward revision in the preliminary estimate of gross domestic product, of 1.3 percentage points, was almost three times as big as the average adjustment since the early 1980s, of 0.5 percentage points.

Coupled with a reported 17 percent decline in new-home sales in January and a 7.8 percent drop in February in orders of durable goods like computers and washing machines, the new data indicated the economy had been much weaker than it seemed.

“I think we are going to discover that the economy is softer than the Fed thinks,” said Robert Barbera, chief economist at ITG in New York.

In congressional testimony, the chairman of the Federal Reserve, Ben Bernanke, offered a sanguine view of the economy. He said the downgrading of growth was “more consistent with our view of the economy” than the previous estimates. He said the Fed expected “moderate growth” going forward, which could pick up by mid-year if housing managed to break its fall.

But concerns over the prospects of a slowing economy were heightened by the steep declines in equity markets around the globe on Tuesday, which came after a near 9 percent drop in the Shanghai market. Investors were also alarmed by comments to a business conference in Hong Kong on Monday by the former Fed chairman, Alan Greenspan. Greenspan warned that the U.S. economy could fall into a recession by the end of the year, although he reportedly qualified those comments on Thursday, saying that recession was not necessarily “‘probable.”

Not many economists agree that a recession is in sight. Still, the slowing economy, economists say, should eventually take its toll on jobs.

“It virtually guarantees labor market deterioration in the form of a higher unemployment rate,” said Jan Hatzius, chief U.S. economist at Goldman Sachs.

While the statement of the Fed’s interest-rate-setting committee in January expressed more concern over inflation than over growth, warning “inflation risks remain,” economists say they think evidence of slower growth is likely to refocus its attention.

“They are going to discover in the next 90 days that they are leaning the wrong way,” Barbera added.

Not all of the economic news was bad. Inflation appeared tamer in the revised GDP report than earlier estimates indicated. The price index for consumer goods excluding food and energy, the inflation gauge most favored by the Fed, rose at an annual rate of only 1.9 percent in the last three months of 2006, less than the 2.1 percent originally reported.

Moreover, about half of the revision to gross domestic product was because of lower inventory accumulation than the government had previously estimated. This means that companies have lower stocks of unsold goods in their warehouses, which would force them to increase production quicker to respond to consumer demand.

The consumer confidence index measured by the Conference Board reached a five-year high in January.

But there are more signs of economic weakness. Trade, which had been thought to add 1.64 percentage points to growth in the quarter, added only 1.5 percentage points, according to the revised data.

The growth in consumer spending in the fourth quarter of last year was brought down a notch in the revised report, to 4.2 percent from 4.4 percent. And much of this growth was merely because of a fall in prices. In nominal dollars, consumer spending slowed markedly.

Housing, it seems, can still fall more. The Commerce Department reported that builders faced a growing glut of unsold homes in January as the pace of new-home sales slowed 16.6 percent — the most in 13 years.

The seasonally adjusted annual sales rate fell to 937,000 last month from 1.1 million in December. Compared with a year earlier, January’s rate was down 20.1 percent. Since the housing market hit its peak in the summer of 2005, new- home sales have fallen off by nearly a third.

The median sales price of a new home declined to $239,800 in January, 2.1 percent below that in January 2006.

A recent slowdown in construction should help bring inventories down, economists said. The Commerce Department said earlier this month that construction of new homes in January slowed to the lowest rate in almost a decade. Inventories remain at historically high levels, however, and some housing experts said it will be months before the numbers reflect any real improvement.

But perhaps the more troubling adjustment in the GDP report was to investment by businesses. Capital investment growth had been one of the sunnier components of economic activity in the second half of last year, picking up some slack from the collapse in residential construction — which declined 19 percent in the final quarter of last year.

Yet according to the revised figures, nonresidential investment in things like factories and computers declined by 2.4 percent in the fourth quarter, much more than the original estimate of a 0.4 percent decline.

“Corporations have become a little more risk averse,” said Nariman Behravesh, chief economist at Global Insight in Lexington, Massachusetts.

The economic outlook could deteriorate further if the current financial turbulence intensifies.

U.S. consumers increased their spending by a healthy 4.2 percent in the fourth quarter, compared with 2.8 percent in the third quarter. But even this figure had been overestimated, at 4.4 percent for the fourth quarter.

On Wednesday, U.S. equity markets recovered some of their loss incurred Tuesday. But many markets in Asia and Europe fell for a second consecutive day. And there are weak points in the U.S. financial system —mortgage- backed bonds, for instance.

Yet, barring a financial disaster, many economists say they believe that a recession will be averted. This is contingent on proper action by the Fed. “There is substantial downward pressure on growth,” Hatzius said. “But with little to worry about inflation pressures, there is no reason that monetary policy couldn’t provide enough support to stabilize things.”

Source:

http://www.iht.com/articles/2007/03/01/business/usecon.php?page=2