US economy shrinks in Q4 2012

The US economy unexpectedly shrank at an annualized rate of 0.1% in Q4  2012, initial official estimates indicate.

If confirmed, it would be the first contraction logged by the US economy since the 2009 global recession.

The world’s largest economy grew 3.1% in July to September.

The fourth quarter period was dominated by the “fiscal cliff” – the spending cuts and tax rises that had been due to come into force from January 1^st, 2013.

These were avoided by a last-minute deal between the Republican-dominated Congress and the White House. However, economists warned at the time that fears of an abrupt cut in government spending were undermining business and consumer confidence.

However, part of that deal includes tax rises for the highest-earning Americans and – more significantly for the economy – the expiry of a payroll tax holiday for all US employees, something which is widely expected by economists to further weigh on growth during the current quarter.

The fourth-quarter shrinkage in economic output comes as a shock to analysts on Wall Street, who had been expecting 1.1% growth according to a poll by news agency Reuters. Not one economist surveyed had predicted an economic contraction.

It will add to pressure on the US Federal Reserve to do more to stimulate the economy. Members of its Federal Open Markets Committee are due to announce the conclusions of their latest policy-setting meeting later on Wednesday, and will have had an advance look at the economic data.

Growth was dragged down by a 22% cut in the federal government’s defence spending – the biggest since 1972, when the US was winding down from the end of the Vietnam War – and by the decision of many businesses to halt the rapid rebuilding of their inventories that began over the summer.

These two relatively volatile components of the data subtracted a combined 2.6 percentage points from the overall growth figure.

Consumer spending did pick up, as did business investment, suggesting that the economy may have some underlying momentum. Sales of computers and cars both made positive contributions to the economy’s performance.

Residential investment also grew 15%, adding to evidence that the housing market has finally turned the corner.

“Frankly, this is the best-looking contraction in US [gross domestic product] you’ll ever see,” said Paul Ashworth, an economist at Capital Economics, in a note to clients.

“The drag from defence spending and inventories is a one-off. The rest of the report is all encouraging.”

The October-to-December period was also negatively affected by Storm Sandy, which caused the closure of many factories and businesses in the New York area, and by a sharp drop in exports.

Growth for 2012 as a whole came in at 2.2%, up from 1.8% in 2011, but still unusually slow compared with previous economic recoveries in the US following recessions in the post-War era.

Looking ahead, domestic spending in the current quarter is expected to be dogged by further uncertainty over the federal government’s tax and spending.

Workers have already experienced a 2% average cut in their take-home pay, due to the expiry of the payroll tax holiday. That means a household earning $50,000 a year will have about $1,000 less to spend.

The income lost is likely to have been behind a sharp fall in consumer confidence recorded by surveys in January.

Meanwhile, the recently re-elected President Barack Obama and Congress are expected to clash once again in the coming months over the debt ceiling.

The US Treasury is approaching the $16.4 trillion legal limit on its total debt, and must gain permission from Congress to borrow the money needed for it to continue meeting its bills.

Last time there was a stand-off over the issue, in the summer of 2011, the political deadlock prompted ratings agency Standard & Poor’s to deprive the US of its top AAA rating, a move that sent stock markets sharply lower.

The US House of Representatives has passed a bill to extend the country’s debt limit until May, deferring the budget debate for a few months at least.