U.S. economy shrank last quarter, worst since recession, before recovering

The U.S. economy shrank at a steep annual rate of 2.9 per cent in the January-March quarter, as a harsh winter contributed to the biggest contraction since the depths of the recession five years ago. But the setback is widely thought to be temporary, with growth rebounding solidly since spring.

The first-quarter contraction reported Wednesday by the Commerce Department was even more severe than the one per cent annual decline it had estimated a month ago. Besides the harsh winter, much of the downward revision reflected a drop in health-care spending. Another factor was a bigger trade deficit than initially estimated.

Though such a sharp decline would typically stoke fears of another recession, analysts see it as a short-lived result of winter storms that shut factories, disrupted shipping and kept Americans away from shopping malls and auto dealerships. They say the economy is rebounding in the April-June quarter. Many expect growth to reach a robust annual rate of at least 3.5 per cent this quarter.

Most analysts also foresee the economy expanding at a healthy rate of around three per cent in the second half of this year.

Reports on consumer spending, manufacturing and business investment have shown a solid rebound this spring. Orders for big-ticket manufactured goods – excluding military hardware – and for core capital goods, a proxy for business investment, rose strongly in May, a report Wednesday showed.

“We have ample evidence that the first quarter was just a temporary setback for the economy, and we are climbing out of the hole in the current quarter,” said Stuart Hoffman, chief economist at PNC Financial.

Last quarter’s 2.9 per cent annual decline in economic activity, as measured by the gross domestic product, followed a 2.6 per cent gain in the fourth quarter. It was the weakest showing since the economy shrank at a 5.4 per cent annual rate in the first quarter of 2009 in the midst of the Great Recession.

Most of the downward revision from the government’s previous estimate of a one per cent annual decline reflected a change in the estimate of spending on health care. The government had previously estimated a strong gain in this category reflecting implantation of provisions of the Affordable Care Act.

But data derived from an actual survey showed the government’s estimate was far too optimistic. Health-care spending, instead of rising at a one per cent rate, had fallen in the first quarter at a 0.2 per cent rate.

Analysts say solid hiring, growth in manufacturing and surging auto sales are contributing to a stronger economy. A stumbling housing recovery has been a concern. But even there, recent data on home sales and construction have been encouraging.

“The larger contraction in GDP in the first quarter is not a sign that the U.S. is suffering from a fundamental slowdown,” said Paul Dales, senior U.S. economist at Capital Economics.

If economists are correct that annual growth will reach around three per cent in the second half of the year, it would be a sharp improvement from the two per cent annual pace of the first five years of this subpar economic recovery.

“We should have a much better second half this year and a much better 2015 than 2014,” said Mark Zandi, chief economist at Moody’s Analytics.

Zandi said he’s forecasting growth of 3.5 per cent to four per cent in 2015. If he’s correct, that would be the strongest year since the economy grew 3.8 per cent in 2004.

“In past recoveries, we have always gotten a year of very strong growth,” Zandi said. “I think we will get that in 2015,” helped by a long-awaited improvement in wage growth.

Of course, the optimistic projections could prove too rosy. Analysts see risks to their forecasts, primarily the possibility that tensions in the Middle East could cause oil prices to surge given the deteriorating crisis in Iraq.

Surging energy prices have preceded earlier economic slowdowns, including the most recent recession.