US economy saw ‘unexpectedly severe’ drop in first three months of year

The US economy shrank in the first three months of the year, contracting by -0.4% in the first quarter, or -1.4% on an annualized basis, its weakest quarter since the early days of the pandemic.

Economic growth slowed markedly at the start of the year. In the last three months of 2021 US gross domestic product (GDP) – a broad measure of the economy – grew by 1.7% or 6.9% on an annualized basis.

The commerce department said the slowdown was caused by a rise in imports and a drop in private inventory investment, exports, federal government spending, and state and local government spending.

Consumer spending, the largest component of the US economy, grew 0.7% in the first quarter – a 2.7% annual rate – despite the impact of the Omicron wave of the coronavirus.

The latest report was worse than economists had expected and was compiled as the war in Ukraine triggered oil price rises that are still working their way through the economy and before China imposed new coronavirus lockdowns that may worsen supply chain problems.

Paul Ashworth, chief US economist at Capital Economics, called the drop “unexpectedly severe”. But he said it was unlikely to deter the Federal Reserve from raising interest rates as it attempts to tackle rising inflation.

The Fed raised rates in March as inflation hit a 40-year high of 7.9%. It meets next week and is expected to raise rates once again. Fed chair Jerome Powell has suggested the central bank may raise rates by 0.5 percentage points, twice March’s rise.

“The unexpectedly severe 1.4% annualised decline in first-quarter GDP growth probably won’t stop the Fed from hiking interest rates by 50 basis points next week, since officials will chalk it up to the temporary impact of Omicron and point to the strength of underlying demand,” Ashworth wrote in a note to investors.

The surprise drop in growth comes as other sectors of the US economy remain strong. Employers have added an average of 600,000 new jobs a month over the last six months and the unemployment rate fell to 3.6% in March, close to its pre-pandemic low.