Economic Growth Surprisingly Slowed To 1.6% In First Quarter

High interest rates are dragging the high-flying U.S. economy back toward earth, and still haven't pushed down inflation to the Fed's 2% target.  

The U.S. economy as measured by the inflation-adjusted Gross Domestic Product (GDP) grew at an annualized rate of 1.6% in the first quarter, down from 3.4% in the fourth quarter of last year and the slowest since mid-2022, the Bureau of Economic Analysis said Thursday. That was below the median forecast of 2.2% according to a survey of economists by Dow Jones Newswires and the Wall Street Journal.

And in a setback in the fight against inflation, the report showed consumer prices accelerated, rising to a 3.4% annual rate from 1.8% in the fourth quarter.

"This report was the worst of both worlds: economic growth is slowing and inflationary pressures are persisting," Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, a financial company in North Carolina, wrote in a commentary.

The growth downturn is a departure from the recent trend of economic figures showing people spending more, and the economy growing faster than forecasters have expected. Economists have anticipated the Federal Reserve’s campaign of anti-inflation interest rate hikes would significantly slow the economy or even send it into a recession, but it’s proved surprisingly resilient.

The Fed has held its key interest rate at its highest since 2001, pushing up borrowing costs on mortgages, credit cards, and other loans in an attempt to quell inflation that flared up as the economy recovered from the pandemic in 2021. Thursday's report showed the economy suffering the downside of this strategy—slower economic growth—while inflation, which had been falling last year, reaccelerates.

Cracks in Economy Starting to Show

Much of the slowdown in GDP came from a decrease in inventory investment, which economists point out, is a volatile statistic prone to rapid swings up and down. Thursday's figures are also an advance estimate and will be revised twice more by the BEA as more data comes in over the next two months.

Still, there were signs of deeper cracks in the economy, possibly pointing to a year of slower growth ahead. Consumer spending, the main engine of the U.S. economy, decelerated in the first quarter according to the GDP report, slowing to a 2.5% annual growth rate from 3.3% in the fourth quarter.

The slowdown, driven by a decrease in spending on material goods, was "a possible sign that elevated rates took a toll on big-ticket spending" by driving up borrowing costs, Oren Klachkin, senior markets economist at insurance company Nationwide, wrote in a commentary.

Decelerating state and local government spending and exports also contributed to the slowdown.

What Does This Mean For Rate Cuts?

The hot inflation shown in the report quashed expectations in financial markets that the Fed will cut the fed funds rate in June. Fed officials have said they are waiting for data to give them confidence that inflation is firmly on the path down to 2%, and Thursday's data cut the wrong direction.

Markets were pricing in a 9.5% chance of a rate cut in June after the report, down from 16.5% the day before according to the CME Group's FedWatch tool, which forecasts rate movements based on fed funds futures trading data.