Not so fast: Slower economic growth ahead

NEW YORK (CNNMoney.com) -- The economy grew at a slower pace than previously estimated at the end of last year, according to a government report Friday, and most economists believe that even slower growth lays ahead.

Gross domestic product, the broadest measure of the nation's economic activity, grew at an annual 5.6% rate in the fourth quarter, according to the Commerce Department, down from the previous reading of a 5.9% rise.

Economists had forecast the growth reading would remain unchanged. The report reinforced the belief of many economists that there will be slower growth ahead in 2010 and beyond.

Many economists caution that most of the growth in the most recent report is due to the fact that businesses are no longer slashing inventories, as they did early in 2009 when demand had fallen sharply and there were worries about whether the economy would avoid falling into another Depression.

That spike in growth due to a turn in inventories is typical at the start of an economic recovery, but it can't last as businesses rebuild the supply of their product needed to meet ongoing demand.

Sustained growth is typically driven by strong demand from consumers and businesses. But spending by consumers, which accounts for more than two-thirds of overall economic activity, grew at only a 1.6% rate in the fourth quarter.

So the fourth-quarter growth might well be the best performance the U.S. economy achieves for the foreseeable future.

Economists surveyed by the National Association of Business Economists are forecasting only 3% growth in the first quarter of 2010, and growth no higher than 3.3% in any quarter through 2011. The Federal Reserve's forecast is for growth of between 2.8% to 3.5% this year, and closer to 4% growth on average in 2011 and 2012.

"Even with the revision, 5.6% growth in the fourth quarter is still a huge number, but it's still inventories driving things," said Kurt Karl, chief U.S. economist for Swiss Re. He is forecasting only 2.7% growth in the first quarter as inventories no longer provide the same spike in growth. He doesn't see growth getting much better the rest of the year.

"It's not going to feel like an economic boom, especially given where unemployment is at close to 10%," he said.

Keith Hembre, chief economist at First American Funds, says he's also looking for growth of between 2.5% and 3% in the first three months of this year.

But he sees slower growth in the second half of the year, as the benefits that would normally add to growth will be offset by the drop in federal government spending from the economic stimulus programs coming to an end.

The revision in the fourth-quarter reading was due to a worse performance in the commercial real estate sector than previous estimates and businesses not rebuilding their inventory as fast as in the earlier reading.

Investment in non-residential buildings fell at an 18% annual rate in the latest reading, not the 13.9% rate of decline in the earlier estimate. Commercial real estate has now become a bigger drag on the U.S. economy than the battered housing sector, which actually added 0.1 percentage point of growth in the most recent reading.

While inventories were the major driver of growth in the report, the final reivision said the change in inventories contributed by 0.1 percentage points less to growth than the previous estimate.

The latest reading also included a slightly higher pace of inflation, which is another headwind for growth, since GDP is adjusted for a change in prices. Prices for goods and services that are purchased by individuals rose at an annual rate of 2.5% in the quarter, and the so-called core reading rose at a 1.8% rate. Both are 0.2 percentage point higher than previous readings.

Still the new readings are still considered relatively mild inflation .The Federal Reserve, which has been more focused on reviving economic growth than on keeping prices in check over the last two years, generally is believed to want to see the core reading between 1% and 2%. So even the higher price reading is unlikely to spur the Fed to raise rates, especially with a lower growth estimate.

The 5.6% growth rate remained the best growth since 2003, and was the second straight quarter of growth, which confirmed the belief of many economists that the recession that started in December 2007 ended at some point in the middle of last year.

But the strong end of 2009 wasn't enough to make up for the even larger declines in the first half of the year. For the full year, GDP fell 2.4%, the biggest decline in the annual reading since 1946, and the sixth-worst annual decline on record.