Economic growth not so strong

NEW YORK (CNNMoney.com) -- The economy grew at a much slower pace in the fourth quarter than previously estimated, according to a government report that was a bit weaker than forecast but included an encouraging inflation reading.

The gross domestic product, the broadest measure of the nation's economic activity, grew at an annual pace of 2.2 percent in the last three months of the year, according to the Commerce Department, down from the 3.5 percent rate the government estimated a month ago and still a bit better than the 2 percent growth rate seen in the third quarter.

Economists surveyed by Briefing.com had forecast the new reading would show a 2.3 percent growth rate.

The chain deflator, which measures prices, was up at an annual 1.7 percent rate, compared to the earlier 1.5 percent reading. Economists had forecast that would stay unchanged.

But the even more closely watched inflation measure in the report, the so-called core PCE deflator, which measures prices paid by consumers for products other than food and energy, rose at an annual pace pace of 1.9 percent, compared to the earlier reading of 2.1 percent.

Economists and investors generally believe the Federal Reserve wants to see that reading in the range of 1 to 2 percent, so the core PCE measure could raise hopes of a Fed rate cut.

"I'm encouraged that we are definitely on the right path," said Jeoff Hall, the chief U.S. economist for Thomson Financial. "If we can stay below 2, then the question is, is it sufficient for the Fed to lower rates?"

Hall said that economic growth would have to slow further before the Fed would feel the need to cut interest rates in order to spur growth.

Much of the lower growth in the fourth quarter was due to a sharply lower spending by businesses. Business investment fell a revised 2.4 percent in the quarter, versus just a 0.4 percent decline in the earlier reading.

But the estimate for consumer spending also was revised lower, to a 4.2 percent growth rate from 4.4 percent in the earlier reading.

Wachovia economist Gina Martin said that the cutback in business investment left inventories at much lower levels than they had been expecting, and she sees business investment picking up later in the year and lifting the economy to a stronger growth rate.

"I think this is an inventory story more than anything else," she said of the slowdown.

But David Wyss, chief economist for Standard & Poor's, said that the lower inflation reading is important because it opens the door for the Fed to put aside its inflation concerns and cut rates if the U.S. stock markets were to suffer after Tuesday's big selloff. The Dow had its worst day since trading resumed after the Sept. 11 terrorists attacks Tuesday, although stocks stabilized and were mostly higher in early trading Wednesday.

"It's too soon to be talking about a cut," said Wyss. "If the markets stabilize, which I think they will do, the Fed won't cut yet. They need to see more evidence of a slowdown."