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The U.S. economy grew at its slowest pace in nearly two years in the first quarter amid some moderation in consumer spending and a wider trade deficit, but an acceleration in inflation reinforced expectations that the Federal Reserve would not cut interest rates before September.

The cooler-than-expected growth reported by the Commerce Department in its snapshot of first-quarter gross domestic product on Thursday also reflected a slower pace of inventory accumulation by businesses and a downshift in government spending. Still, domestic demand remained solid, underpinned by business investment and a recovering housing market.

“This report comes in with mixed messages,” said Olu Sonola, head of economic research at Fitch. “If growth continues to slowly decelerate, but inflation strongly takes off again in the wrong direction, the expectation of a Fed interest rate cut in 2024 is starting to look increasingly more out of reach.”

Gross domestic product increased at a 1.6 per cent annualized rate last quarter, the slowest pace since the second quarter of 2022, the Commerce Department’s Bureau of Economic Analysis said. Economists polled by Reuters had forecast GDP rising at a 2.4 per cent rate, with estimates ranging from a 1.0 per cent pace to a 3.1 per cent rate.

The economy grew at a 3.4 per cent rate in the fourth quarter. The first quarter growth’s pace was below what U.S. central bank officials regard as the noninflationary growth rate of 1.8 per cent.

Price pressures heated up by the most in a year, with a measure of inflation in the economy increasing at a 3.1 per cent rate after rising at a 1.9 per cent pace in the October-December quarter.

The personal consumption expenditures (PCE) price index excluding food and energy surged at a 3.7 per cent rate. That was the fastest rise in that measure in nearly a year and followed a 2.0 per cent pace of increase in the fourth quarter.

The so-called core PCE price index is one of the inflation measures tracked by the Fed for its 2 per cent target. Inflation was boosted by increases in the costs of services like insurance and housing, which offset a decline in goods prices such as motor vehicles and parts. The strong readings pose an upside risk to March PCE inflation data due to be released on Friday.

The Fed is expected to leave its policy rate unchanged in the 5.25 per cent-5.50 per cent range next week, having hiked it by 525 basis points since March of 2022. It has kept the benchmark overnight rate at this level since July.

Financial markets initially expected the first rate cut to come in March, which then got pushed back to June and now to September as data on the labour market and inflation continued to surprise on the upside this year.

Stocks on Wall Street were trading lower. The dollar rose against a basket of currencies. U.S. Treasury yields rose.

A significant slowdown in the labour market is not evident as yet. The Labor Department’s weekly jobless claims report showed initial claims for unemployment benefits fell 5,000 to a seasonally adjusted 207,000 in the week ending April 20.

The number of people receiving benefits after an initial week of aid, a proxy for hiring, declined 15,000 to 1.781 million during the week ending April 13. The so-called continuing claims data covered the period during which the government surveyed households for April’s unemployment rate.

Continuing claims fell between the March and April survey periods, implying the unemployment rate was likely unchanged after dipping to 3.8 per cent last month from 3.9 per cent in February.

Low layoffs are keeping wages high, sustaining consumer spending, which accounts for more than two-thirds of economic activity. Consumer spending grew at a still-solid 2.5 per cent rate, slowing from the 3.3 per cent growth pace rate notched in the October-December quarter. Spending was driven by health care, financial services and insurance, which more than offset a decline in goods, including motor vehicles and gasoline.

Spending is likely to gradually cool this year. Lower-income households have depleted their pandemic savings and are largely relying on debt to fund purchases. Recent data and comments from bank executives indicated that lower-income borrowers were increasingly struggling to keep up with their loan payments.

Though income increased at a $407.1-billion rate compared with the fourth quarter’s $230.2-billion pace, the gains were eroded by inflation and higher taxes. Income at the disposal of households after accounting for inflation and taxes rose at a 1.1 per cent rate versus a 2.0 per cent pace in the October-December quarter.

That meant less saving. The saving rate decreased to 3.6 per cent from 4.0 per cent in the prior quarter.

Inventories were whittled down amid the still-strong pace of consumer spending, rising at a $35.4-billion rate after increasing at a $54.9-billion pace in the fourth quarter. Inventories subtracted 0.35 percentage point from GDP growth.

Part of the spending was satiated with imports, which resulted in the trade deficit widening to $973.2-billion from $918.5-billion in the October-December quarter. Trade chopped off 0.86 percentage point from GDP growth.

Government spending decelerated to a 1.2 per cent rate from the 4.6 per cent pace notched in the October-December quarter amid a decline in federal government outlays, mostly defence.

Excluding inventories, government spending and trade, the economy grew at a 3.1 per cent rate after expanding at a 3.3 per cent rate in the fourth quarter.

Domestic demand was supported by a pickup in business spending as companies invested in artificial intelligence.

Investment in nonresidential structures like factories contracted for the first time in more than year as the boost from policies by President Joe Biden’s administration to bring the production of semiconductor manufacturing back to the United States faded.

Residential investment recorded its fastest pace of growth since the fourth quarter of 2020, thanks to rising home sales and housing construction, despite higher mortgage rates.

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