The economy slowed sharply in the closing months of 2012, as today’s advance estimate from the Department of Commerce indicated that it contracted by 0.1% during the quarter. That follows a strong 3.1% annualized rate in the third quarter. While still subject to revision, if that result holds, it would represent the first quarter of economic contraction since the second quarter of 2009, when the last recession was in its final months.
The biggest drivers of the decline were sharp reductions in business inventories and federal defense spending, both of which were significant contributors during the prior quarter.
On a positive note, the recovery in housing continued during the quarter, posting a strong gain of 15.3% annualized. The fact that housing activity continues to gather steam even as other sectors of the economy faltered is indicative of the underlying pent-up demand and robustness of that recovery.
Personal consumption increased during the quarter to 2.2% as consumers loosened their purse strings during the period leading up to the holiday season. That uptick might have been the final binge before consumers tighten their belts in response to higher payroll and income taxes that took effect January 1. With take-home pay for the average household declining, there’s no question that consumers will adjust their spending; the question is how significant that adjustment will be.
The importance of yesterday’s report on consumer confidence shouldn’t be overlooked, given the severity of the decline. With confidence already sagging, additional evidence that the economy is softening could further heighten consumer anxiety. Falling confidence, coupled with lower disposable income, can only be viewed as a negative for the critical consumer sector and represents a significant near-term risk to the expansion.
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