Inventories hurt U.S. third quarter GDP

October 29, 2015 09:02 AM

U.S. economic growth braked sharply in the third quarter as businesses cut back on restocking warehouses to work off an inventory glut, but solid domestic demand could encourage the Federal Reserve to raise interest rates in December.

Gross domestic product increased at a 1.5% annual rate after expanding at a 3.9% clip in the second quarter, the Commerce Department said on Thursday.

The inventory drag, however, is likely to be temporary and economists expect growth to pick up in the fourth quarter given strong domestic fundamentals.

The Fed on Wednesday described the economy as expanding at a "moderate" pace and put a December rate hike on the table with a direct reference to its next policy meeting. The U.S. central bank has kept benchmark overnight interest rates near zero since December 2008.

"Underlying growth is still strong, or at least, strong enough to handle interest rates not being at emergency low levels anymore," said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto. Prices for U.S. Treasury debt fell on the data, while the dollar trimmed losses against a basket of currencies.

The economy has struggled to sustain a faster pace of growth since the end of the 2007-2009 recession, with average yearly growth failing to break above 2.5%. Economists had forecast GDP rising at a 1.6% rate in the third quarter.

Businesses accumulated $56.8 billion worth of inventory in the third quarter, the smallest since the first quarter of 2014 and down sharply from $113.5 billion in the April-June period. There were declines in manufacturing, wholesale and retail inventories.

The small inventory build sliced off 1.44 percentage points from third-quarter GDP growth, the largest since the fourth quarter of 2012.

"That inventory drawdown represents a bit of a healthy purge that should set the economy up for stronger growth in the coming quarters," said Jim Baird, partner and chief investment officer for Plante Moran Financial Advisors in Kalamazoo, Michigan.

Consumers save the day

The blow from inventories was, however, blunted by bullish consumers, who are getting a tailwind from cheaper gasoline and firming housing and labor markets.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, grew at a 3.2% rate after expanding at a 3.6% pace in the second quarter. A measure of private domestic demand, which excludes trade, inventories and government spending, rose at a sturdy 3.2% pace.

Spending is likely to remain supported by a fairly healthy labor market and low inflation, which is boosting household purchasing power. Income at the disposal of households increased 3.5% in the third quarter after rising 1.2% in the prior quarter.

A separate report from the Labor Department showed new applications for unemployment benefits hovering near levels last seen in late 1973.

With the dollar continuing to strengthen, export growth decelerated in the third quarter. The drag was, however, offset by a slowdown in imports, especially automobiles, leaving the impact from trade on GDP growth neutral.

Ongoing spending cuts in the energy sector also undermined growth. A plunge in oil prices has prompted oil field companies like Schlumberger and Halliburton to slash investment.

Schlumberger said this month it did not expect a recovery in demand before 2017 and anticipated that exploration and production spending would fall again in 2016.

Spending on mining exploration, wells and shafts tumbled at a 46.9% rate. This category dropped at a 68 % pace in the second quarter. Investment on nonresidential structures contracted at a 4.0% pace, also weighed down by weak spending on commercial and healthcare structures.

Despite strong domestic demand, inflation retreated because of dollar strength and cheaper gasoline.

The personal consumption expenditures (PCE) price index roseat a 1.2% rate after rising 2.2% in the second quarter. Excluding food and energy, prices increased at a 1.3% pace, slowing from a 1.9% rate in the second quarter.

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