Economy posts surprising growth

NEW YORK (CNNMoney.com) -- Economic growth picked up in the fourth quarter, the government said Wednesday, a surprisingly strong showing given the ongoing slump in the housing market.

The reading means the economy grew at a slightly stronger pace in 2006 than in 2005, but that's unlikely to spur the Federal Reserve to change its recent policy of holding interest rates steady, economists said.

Gross domestic product, the broadest measure of the nation's economic activity, grew at an annual 3.5 percent rate in the quarter, according to the government's first reading for the period. That compared to 2 percent growth in the third quarter.

Economists surveyed by Briefing.com had forecast a 3 percent pace of growth in the fourth quarter.

The fourth quarter reading resulted in a growth rate of 3.4 percent for the full year, up slightly from the 3.2 percent pace seen in hurricane-impacted 2005.

Unusually warm weather in much of the nation may have contributed to the strong showing.

"The fourth quarter number is probably overstated due to the weather, and we're still expecting a slowdown in the first half of 2007," said John Silvia, chief economist at Wachovia. "But you look at the data and you have to say the consumer is doing fine, exports were solid. This is exactly what everybody wants."

The pace of growth is actually helped by the relatively low inflation rate in the fourth quarter because of falling energy prices in the period. Since GDP is adjusted for inflation, smaller gains in prices subtract less from growth than during periods of higher inflation.

Two other government readings showed declining inflation pressures in the fourth quarter.

In the GDP report, the so-called PCE deflator, which measures prices paid by consumers, fell 0.8 percent over the past 12 months. The core PCE deflator, which excludes food and energy, was up 2.1 percent from a year earlier, down from a 2.2 percent rate in the third quarter.

Separately, the Labor Department's Employment Cost Index, which measures the labor costs paid by employers, rose 0.8 percent in the fourth quarter, down from a 1 percent gain in the third quarter and below economists' forecast for another 1 percent rise.

The report comes as the Fed is holding a two-day meeting to weigh what it should do with interest rates. The central bank is generally believed to want to see the core PCE deflator in the range of 1 to 2 percent.

Silvia said the GDP report gave no excuse for the Fed to start cutting rates in order to spur a slowing economy. During much of 2006, economists and investors had been betting on slower growth and Fed rate cuts this year.

But Silvia said at this point he believes the inflation pressures have retreated enough to stop the Fed from raising rates in order to cool the economy and maintain price stability.

"It comes down to how tough does the Fed want to be on inflation?" said Silvia, referring to the chance of a rate hike. "Do you really need it [the core PCE reading] down to 2.0 percent or do you declare victory at 2.1 and leave rates where they are?

"Myself, I would declare victory," he added. "We may not have beaten the spread, but we won the Super Bowl."

The Fed's pregnant pause

Bush stresses taxes, trade in speech

Consumer confidence inches up in January