Economic growth rises to 2.5%

Consumer spending, which makes up more than two-thirds of the economy, was unexpectedly robust in the first quarter. (Spencer Platt / Getty Images / April 26, 2013)

WASHINGTON — The nation's sluggish recovery can't seem to catch a break.

Persistent federal spending cuts and a slowdown in business investments thwarted hopes for stronger economic growth in the first quarter, setting up more modest gains in jobs and income into the summer.

The U.S. economy expanded at an annual rate of 2.5% in the first three months of the year, the Commerce Department reported Friday.

That was a big improvement from the measly 0.4% increase in the fourth quarter, when deep defense cuts and smaller stockpiling by companies slashed growth. But the latest measure of the nation's gross domestic product was still middling and fell short of most analysts' forecast of about 3%.

As expected, farms and other businesses replenished inventories as the year began, accounting for a good part of the acceleration in the GDP, or the total value of all goods and services produced inside U.S. borders.

Consumer spending, which makes up more than two-thirds of the economy, also was unexpectedly robust in the first quarter. Even as after-tax incomes shrank over the quarter, people kept buying more cars and other long-lasting products.

And spending for services, including utilities, insurance and healthcare, rose in the first quarter at the fastest pace since 2005.

Although the private economy is hanging tough, the public sector proved to be a bigger drag than economists had feared.

After falling at an annual rate of 7% in the fourth quarter, government spending and investment, mostly federal, slid 4.1% in the first three months this year. National defense expenditures dropped 11.5% in the quarter, after plunging 22.1% in the previous quarter.

"The U.S. budget deficit is shrinking at the fastest rate since demobilization following the second World War," said James Marple, a senior economist at TD Bank. Government cutbacks will continue to hold back economic growth in the second and third quarters, he said.

Some of the Pentagon spending reductions appear to have been made in anticipation of the automatic budget cuts that took effect in March, but more recently non-defense agencies have begun to furlough workers.

Those unpaid leaves will affect incomes and spending in the coming months, though the House on Friday approved a measure to stop the furlough of at least one large group of highly paid workers: air traffic controllers.

Bank of America economists had estimated that the lost wages from the furloughs and costs related to airport delays would amount to $400 million a year.

Still, analysts on average see economic growth retreating to a number closer to 1% in the current quarter before picking up later this year as government spending cuts fade and the private sector gains steam.

Starting next year, assuming no major shocks, top Federal Reserve officials and many private economists believe that the nation could finally enter a period of significantly stronger growth.

Friday's report did not change that basic outlook, but it nonetheless highlighted the uncertain and fragile state of consumers and businesses.

Consumer spending in the first quarter jumped at a 3.2% annual rate, the fastest since late 2010 and nearly double the pace of last year's fourth quarter. This reflected pent-up demand for goods and services and the recovering housing market.

"The strengths in consumer spending are now attributable to gains in household wealth, including rising home values and stock prices as well as reduced debts," said Richard Curtin, director of the Thomson Reuters/University of Michigan consumer confidence survey.

Curtin noted that the improvement has been particularly strong among upper-income families.

But the big question is, can the strong spending last? Many economists do not think so.