Consumer Spending Helps U.S. Overcome Budget Cuts: Economy

Strength in consumer spending and business investment is helping the U.S. economy overcome government cutbacks, underlining forecasts for a growth pickup later in the year.

Gross domestic product rose at a 2.4 percent annualized rate in the first quarter, revised from the 2.5 percent pace reported last month, figures from the Commerce Department showed today in Washington. Household spending expanded 3.4 percent, the most since the last three months of 2010.

Gains in wealth from rising stock and home prices, which helped Americans weather an increase in the payroll tax at the start of the year, will probably continue to boost the biggest part of the economy throughout 2013. At the same time, the damage from federal budget cuts is projected to recede in the last six months of the year, indicating growth will accelerate.

“The private economy in the U.S. is still pretty strong,” said Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts, who correctly projected the GDP revision. “We seem to have dodged a lot of bullets. The worst of the sequester is behind us and we avoided the fiscal cliff. Yes, taxes were up but it doesn’t seem to have had a huge negative effect.”

Private final sales to domestic purchasers, a measure of spending which includes only consumer spending and business investment minus inventories, climbed at a 3.4 percent annualized rate last quarter after growing at a 3.5 percent pace in the final three months of 2012, according to Bloomberg News calculations. It marked the strongest back-to-back readings since mid-2005.

Shares Climb

Stocks rose, following the Dow Jones Industrial Average’s biggest drop in four weeks, on expectations the Federal Reserve will maintain stimulus. The Standard & Poor’s 500 Index climbed 0.4 percent to 1,654.41 at the close in New York.

Elsewhere today, economic confidence in the euro area increased in May, adding to signs the region is beginning to emerge from the longest recession in the single-currency era. An index of executive and consumer sentiment rose to 89.4 from 88.6 in April, the European Commission in Brussels.

The median forecast in a Bloomberg survey called for no revision for U.S. GDP from the 2.5 percent pace initially reported. Estimates of the 81 economists polled ranged from gains of 2 percent to 3 percent.

Another report today showed more Americans filed claims for unemployment insurance payments last week as holiday closures kept five states from completing a full count. Applications for jobless benefits increased by 10,000 to 354,000 in the week ended May 25, the Labor Department said.

Beat Forecast

The gain in consumer spending last quarter exceeded the median forecast in the Bloomberg survey which called for a 3.3 percent increase. It was revised up from a previous estimate of 3.2 percent and added 2.4 percentage points to GDP.

Williams-Sonoma Inc., the San Francisco-based owner of the Pottery Barn and West Elm home-goods chains, reported an 8.6 percent increase in net revenue in the three months ended May 5.

Shoppers “are spending money to redecorate,” Laura Alber, president and chief executive officer, said on a May 23 earnings call. “Whether they’re moving or not, it’s time to get some new stuff in your home after a period when I think people didn’t feel comfortable spending money on their homes.”

Today’s report also showed business investment in equipment and software rose more than previously estimated, climbing at a 4.6 percent annualized rate.

Gains in household and business spending mean the economy is better equipped to withstand $85 billion in fiscal tightening and the lagged effect from a two percentage-point increase in the payroll tax that went into effect at the start of 2013.

Government Spending

Government outlays, down for the 10th time in the past 11 quarters, fell more than previously estimated amid the winding down of military operations in Iraq and Afghanistan. Government spending will be limited by n planned federal cuts, or sequestration.

The back-to-back cuts in defense spending over the past two quarters on average were the biggest since 1954, when the military demobilized after the Korean War.

“The underlying demand picture on the private economy is coming in pretty strong,” said Ted Wieseman, an economist at Morgan Stanley in New York. “It’s pointing to some upside in growth as the fiscal drag begins to wane.” That confirms his firm’s prior forecast of a second-half pickup, and “it’s coming through in a stronger way than we anticipated,” he said.

Growth may cool this quarter to a 1.6 percent annualized rate, according to the median forecast of economists in a separate Bloomberg survey conducted earlier this month. GDP is projected to climb at an average pace of 2.4 percent in the second half of the year.

Corporate Profits

Today’s report also offered a first look at corporate profits. Before-tax earnings fell 2.2 percent in the first quarter from the previous three months, and were up 3.6 percent from the same period last year. Last quarter’s drop was led by a slump in profits from overseas operations, pointing to a slackening in global growth.

Residential construction increased at a 12.1 percent annualized rate growing at a 22.1 percent pace in the fourth quarter.

The rebound in housing will continue to underpin growth as borrowing costs near a record low attract buyers and drive building, while rising house values lift wealth. Another report today showed pending sales of previously owned houses rose 0.3 percent in April after a 1.5 percent gain the prior month, figures from the National Association of Realtors showed today in Washington.

Growing Confidence

Consumer sentiment last week hovered near a five-year high as more Americans said the economy was improving and their finances were mending, another report today showed.

The Bloomberg Consumer Comfort Index was at minus 29.7 in the period ended May 26 compared with minus 29.4 a week earlier. The margin of error for the figure is 3 percentage points. Views on the current state of the economy matched a mid-April reading as the strongest since January 2008.

Bigger gains in employment and wages are needed to ensure spending gains are sustained. The economy remains hampered by high unemployment and government spending cuts, and tightening policy too soon would endanger the recovery, Federal Reserve Chairman Ben S. Bernanke said last week.

“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further,” Bernanke said in congressional testimony in Washington.

Today’s GDP estimate is the second of three for the quarter, with the final release scheduled for late June when more information becomes available.