America heads towards recession

A slump in consumer spending caused the US economy to shrink in the third quarter of the year at the fastest pace it has contracted since the recession of 2001.

The first estimate of GDP for the three months ended 30 September provided long-awaited confirmation that the slowdown has turned into an outright contraction, after two years of gathering storm clouds that first appeared over the US housing market.

A day after the Federal Reservecited weakening consumer confidence to justify another sharp cut to interest rates, the Commerce Departmentcalculated that consumer spending slipped by 3.1 per cent in the third quarter. That is the worst drop since 1980, when the US was plunging into a deep recession, and it follows 1.2 per cent growth in the second quarter of this year, when households were handed tax-rebate cheques that helped them keep on spending.

Consumer spending accounts for 70 per cent of the US economy, and economists have been increasingly nervous over the outlook for GDP since a consumer confidence survey earlier this week registered an all-time low. The consensus view is that the US willsuffer at least one more quarter of negative growth, satisfying a common definition of a recession, but economists fret that the stresses in thecredit market will keep choking the real economy into next year.

The bright spot yesterday was that the 0.3 per cent contraction in US GDP was a little less severe than predicted. The average of economists' forecasts was for a 0.5 per decline.

Richard Snook, senior economist at the Centre for Economic and Business Research, said: "With much economic data over the last month proving to be more negative than expected, these figures will likely provide some reassurance. The very marginal contraction shows some resilience in the US economy although recession remains certain."

Faced with tighter restrictions on credit and growing job insecurity, US consumers pulled in their horns and eschewed big purchases such as cars and other durable goods. These types of big orders plunged 14.1 per cent. Declining investment in the housing market also acted as a drag on GDP, and business investment likewise contracted. US unemployment remained high, other figures revealed yesterday. New claims for unemployment benefit were 479,000 last week, unchanged from the previous seven days and confounding economists' hopes for a small drop. The figure is above the average for the 2001 recession.

Motorola, the telecoms equipment manufacturer, is planning to cut 3,000 jobs worldwide, according to reports last night. And American Express announced big lay-offs, saying it would cut 10 per cent of its global workforce, some 7,000 staff, mainly in middle management. The credit card giant said consumers were spending less, and more of them were having trouble keeping up with payments. Moody's, the credit rating agency, predicted yesterday that some retailers will get into financial difficulty over Christmas, and next year could see a big spike in debt defaults in the industry. Holiday sales are the industry's crucial test, because most retailers rely on them for the bulk of their annual sales, earnings and cash flow, said Margaret Taylor, Moody's senior credit officer. "Beyond the holidays, uncertainty about jobs, stock prices and the overall economy is bound to keep consumers focused on the essentials in 2009."

The origins of the US recession lie in the drop in house prices, which began two years ago in the previously booming markets of the sunbelt across the south of the country. As that bubble turned to bust, the effects rippled through the financial markets, bringing down major banks and causing others to dramatically scale back the lending that is the lifeblood of the economy. The effects are still being felt around the world. Yesterday, the Japanese government said it would introduce its second economic stimulus plan in three months, a 5 trillion yen (£31bn) package.

Meanwhile, the economic outlook darkened in Europe again. The GfK NOP barometer of consumer sentiment in the UK slipped back to the minus-36 score seen in August.