Economy growing, but at moderate pace

Growth steadied at a 4.2 percent annual pace last quarter with the economy firing on all pistons, the Commerce Department reported yesterday.

Consumers spent more during the winter quarter, but also paid higher prices for items from energy to medical care. Higher health care and pension costs also drove up employee benefit costs by 7 percent, the most in two decades, raising hurdles for businesses looking to hire workers, the Labor Department reported separately.

The overall picture of growth portrayed in the Commerce Department report showed the expansion continuing, but at a more moderate pace for areas such as housing, exports and business investment.

“The U.S. economy is definitively on a path to prosperity,” said Richard Yamarone, economist with Argus Research Corp., who said the 4.2 percent growth rate — nearly identical to the fourth quarter’s 4.1 percent rate — was “not too strong, not too weak, but just right.”

While the quarter’s growth was not as robust as economists expected, it coincided with a long-awaited revival of job growth — previously a missing ingredient in the two-year-old recovery.

Consumers this winter were held back by an unusually strong 3.2 percent jump in prices — the biggest in three years.

“A majority of consumers’ discretionary income was dedicated to paying higher home-heating and natural-gas bills during a prolonged winter cold spell,” Mr. Yamarone said, while businesses got rammed with sharply higher health care and pension costs.

“Continued acceleration of energy prices could be harmful to economic growth” as consumer incomes get pinched in the months ahead with the tailing off of tax cuts and mortgage refinancings, he said.

“Sustained high energy prices, particularly of natural gas, may put upward pressure on electricity prices as we head into the summer air-conditioning season,” he said. That will pose a “double whammy” for consumers already facing record high gasoline prices during the spring and summer driving season.

Financial markets were disappointed by yesterday’s report as economists had predicted a stronger growth rate of 5 percent or higher, based on the economy’s gangbusters performance during March, the last month of the quarter.

Still, the quarter was “very healthy,” said Bill Cheney, chief economist at MFC Global Investment Management. He noted that one disappointing aspect of the report — businesses spent less than expected stocking their shelves — was actually “good news.”

The surprisingly small $15.3 billion spent on inventories likely postpones growth to future quarters, he said. “The shelves will need to be restocked, so we may see stronger growth later in the year.”

Also, the inventory figure may be revised higher in an updated report by the department next month, he said.

Manufacturing — the hardest hit sector of the economy — continued its revival during the quarter, though at a more subdued pace.

Export growth dropped to 3.2 percent from a stunning 20.5 percent gain posted during the fourth quarter, while business spending also cooled from double-digit rates.

David Huether, chief economist with the National Association of Manufacturers, hailed the robust 11.5 percent growth of business investment in equipment seen in the report.

“This is the third consecutive quarter of double-digit growth and a major reason for the robust pace of manufacturing activity since the middle of last year,” he said, predicting that the beleaguered industrial sector will outperform the rest of the economy this year.

The Bush administration and Republicans on Capitol Hill attributed the quarter’s strong performance to $350 billion of tax cuts they enacted last year.

Democrats noted that the tax cuts and sharply higher defense spending and deficits have failed produce many jobs, however, despite solid growth.

“The two most important factors that drove growth in the first quarter do not appear to be sustainable,” said Scott Lilly, senior fellow at the Center for American Progress, a liberal think tank.

“Government defense spending grew by 15 percent while personal taxes fell by $26 billion,” he said. “While the rapid explosion of the federal budget deficits has been a powerful force in driving economic expansion in the short term,” that won’t last much longer as Congress is now focused on trimming the deficit, he said.

By next year, “a reduced rate of federal borrowing will slow rather than speed economic expansion,” he said.