Economy returns to growth after deep slump

WASHINGTON Thu Oct 29, 2009 7:45pm EDT

1 of 3. Workers construct a house by developer KB Home in Gilbert, Arizona, October 20, 2009.

Credit: Reuters/Joshua Lott

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WASHINGTON (Reuters) - The U.S. economy grew in the third quarter for the first time in more than a year as government stimulus helped lift consumer spending and home building, fueling an unexpectedly strong advance.

Signaling the end of the worst recession in 70 years, the Commerce Department on Thursday said the economy expanded at an annual rate of 3.5 percent in the July-September period, snapping four down quarters with its fastest growth pace since the third quarter of 2007.

The report buoyed global stock markets, which were also cheered by improving third-quarter corporate earnings, including higher-than-expected profits from consumer product giants Procter & Gamble Co and Colgate-Palmolive Co.

It raised hopes for further improvement in corporate profits and sent stocks on Wall Street rallying after four days of losses. The Dow Jones industrial average and the Standard & Poor's 500 Index notched their biggest percentage gains since July 23.

Prices for U.S. government debt and the U.S. dollar fell as traders exited safe havens.

"The economy has emerged with gusto from the deepest recession since World War Two," said Harm Bandholz, economist at UniCredit Markets and Investment Banking in New York. "The short-term prospects for the economy remain good."

Economists polled last week had expected a 3.3 percent GDP gain, but many had cut those estimates in the past couple days. As it turned out, growth was fairly broad-based with solid gains in consumer spending, exports and home construction.

But it was also driven by emergency government programs like the popular "cash for clunkers" incentive for new auto purchases and an $8,000 tax credit for first-time home buyers.

The auto discount program ended in August and the home tax credit is due to expire next month, although Congress is working on a plan to extend it.

Stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter.

In the absence of government support, there are fears the brisk growth pace will not extend into coming quarters, with rampant unemployment also inflicting damage.

"The economy is entirely dependent on federal deficit spending at the moment. But the stimulus will not fade right away ... that means we can rely on solid growth continuing through the first quarter of next year," said Chris Low, chief economist at FTN Financial in New York.

"Once the government steps aside, growth is likely to fall back to a 1 to 2 percent rate of growth."

The United States is entering recovery following in the footsteps of major economies like China and the euro zone.

For a graphic see here

MORE WORK NEEDED

President Barack Obama, who has sought to breath life into the economy with a $787 billion stimulus package, said the brisk growth pace was proof the measures were effective, but he said more work was still needed.

"While this report today represents real progress, the benchmark I use to measure the strength of our economy is not just whether our GDP is growing, but whether we are creating jobs, whether families are having an easier time paying their bills, whether our businesses are hiring and doing well," Obama told small business leaders.

Officials from the Federal Reserve meet on Tuesday and Wednesday and will sift through the economic tea leaves to try to determine whether a sustainable recovery is building. They are widely expected, however, to keep ultra-easy monetary policies in place for some time.

Consumer spending, which normally accounts for more than two-thirds of U.S. economic activity, rose 3.4 percent in the third quarter, the fastest advance since the first quarter of 2007. Spending fell 0.9 percent in the previous quarter.

Residential investment jumped 23.4 percent, adding to GDP for the first time since 2005 and putting a punctuation mark on the end of the housing slump that drove the recession. It was the biggest rise in homebuilding in more than 23 years.

A sharp slowing in the pace of inventory liquidation by businesses also aided recovery. Inventories fell $130.8 billion after a record $160.2 billion plunge in the second quarter, with the slowdown adding nearly 1 percentage point to growth.

Analysts hope a further slowing will help prop up the economy in the fourth quarter, even if consumers retreat. With inventories at a lean level, any rise in consumer spending is more likely to lead to an increase in output.

"Longer term, inventory stabilization buys time to generate the conditions, most importantly job and income growth, for a sustained healthy expansion," said Stephen Stanley, chief economist at RBS in Greenwich, Connecticut.

The weaker dollar boosted exports but a rise in imports subtracted from GDP. Federal government spending helped growth but both state and local governments were a drag.

Business investment fell at a 2.5 percent pace as spending on nonresidential structures dropped sharply.

There are a signs the labor market, the missing piece of the recovery puzzle, is inching toward stability.

The Labor Department said on Thursday that the number of U.S. workers filing new claims for jobless benefits dipped by 1,000 last week to 530,000, while the number still on the rolls after an initial week of aid fell to the lowest level in seven months.

(Additional reporting by Alister Bull; Editing by Kenneth Barry)

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