U.S. economy grows at slowest pace in 3 years

WASHINGTON - The economy grew at a sluggish 1.1 percent rate in the final quarter of last year, the slowest pace in three years, amid belt-tightening by consumers facing spiraling energy costs.

The sharp slowdown surprised economic forecasters, although even with the poor showing the the economy registered respectable overall growth of 3.5 percent for all of 2005 — a year when business expansion was undermined by devastating Gulf Coast hurricanes.

The 1.1 percent rate marked a considerable loss of momentum from the third quarter’s brisk 4.1 percent pace and the average 3.6 percent rate of the past four quarters. Economists noted that the GDP figure published Friday was preliminary, and the Bureau of Economic Analysis generally has revised the figure upward in previous quarters.

But still, some analysts said the surprising slowdown means the Fed's long series of interest-rate hikes is beginning to bite.

"The overall message that the lagged impact of the Fed's tightenings are beginning to percolate through the system is coming through loud and clear," said David Rosenberg, chief North American economist for Merrill Lynch, a research note.

The weakness reflected consumers a pullback in consumer spending, especially on motor vehicles, a a sharp downturn in government spending on defense, a category that can be volatile.

Despite what many described as a disappointing report, the Federal Reserve is considered nearly certain to raise short-term interest rates by another quarter-percentage point Tuesday at the final policy-setting meeting of Chairman Alan Greenspan's 18-year term.

But the slowdown raised hopes among some investors that the Fed will shift to a "neutral stance" and leave rates unchanged at the first meeting led by incoming Chairman Ben Bernanke March 28.

Partly as a result, stock prices rose sharply Friday, with broad indicators up nearly 1 percent. Investors also were encouraged by generally good corporate earnings and a surprisingly strong report that new-home sales rose 2.9 percent in December and set a fifth straight annual record for 2005.

In the GDP report, economists said the slowdown in the final quarter was more of a temporary setback rather than any harbinger of a sustained period of economic weakness ahead.

“The economy hit a pothole in the fourth quarter. I’m not at all worried about the health of the economy,” said Mark Zandi, chief economist at Moody’s Economy.com. Zandi believes that economy is already doing better in the current January-to-March quarter and predicts economic growth will come in around a 4 percent pace.

Consumers turned cautious at the end of last year as high energy prices and rising borrowing costs took a toll on their budgets.

Consumer spending rose by just 1.1 percent pace in the fourth quarter, the slowest since the second quarter of 2001 when the economy was suffering through a recession.

Most of the weakness came as people sharply cut back on purchases of big-ticket goods, including cars and appliances. Spending on such “durable” goods dropped by a hefty 17.5 percent rate in the final quarter, the sharpest decline since the first quarter of 1987.

Another source of weakness in the fourth quarter was government spending, which had contributed to overall economic growth in prior quarters. In the fourth quarter, government spending declined at a 2.4 percent pace, the largest drop since the first quarter of 2000.

Administration officials rushed to play down the latest GDP number, with Treasury Secretary John Snow and White House economic adviser Al Hubbard hitting the airwaves to insist the expansion was solid, job growth was strong and businesses were healthy.

“By virtue of every index of economic performance, we’re going the right way,” Treasury Secretary John Snow told a Vermont talk radio show.

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