Slow growth and rising prices raise fears of stagflation in US

The US economy slowed more sharply than expected in the first three months of the year, and is growing at its weakest pace since 2003.

The latest quarterly GDP figure of 1.3 per cent was barely half the growth rate of the previous three months, and well below the 1.8 per cent that economists had been expecting.

But at the same time, prices data within the figures suggested swelling inflationary pressures that may crimp the Federal Reserve's ability to kick-start the economy through interest rate cuts.

The teetering American housing market continues to be the main culprit in the slowdown, with residential building activity sliding 17 per cent in the quarter. That was the sixth straight decline, and followed a fall of 19.8 per cent in the fourth quarter.

House prices are tumbling in many parts of the country and mortgage arrears are rising among the poorest Americans, prompting builders to scale back their development plans.

However, slowing construction activity has yet to swell the unemployment figures or - the GDP report showed yesterday - to undermine the strength of the US consumer. First-quarter consumer spending grew at a 3.8 per cent annual rate, down modestly from the 4.2 per cent rate in the previous three months but a reservoir of strength since consumer spending accounts for two-thirds of national economic activity.

The dollar plunged to new lows against the euro in the immediate wake of the report, and Treasury prices initially gained across the board on hopes that weaker growth might mean lower interest rates later this year. However, they later gave up most of the gains because of concern about higher-than-forecast core prices in the GDP report.

The price index for personal consumption expenditures rose by 3.4 per cent after decreasing 1.0 per cent in the fourth quarter, as fuel and food costs increased. Excluding food and energy, prices grew 2.2 per cent, after increasing 1.8 per cent in the fourth quarter. This is a measure closely watched by the Federal Reserve, and the central bank chairman, Ben Bernanke, has argued that the ideal rate is between 1 and 2 per cent.

Steve Barrow, a foreign exchange specialist with Bear Stearns in London, expressed concern at the mix of weaker-than-expected growth and higher prices. "That's the worst combination," he said. "The idea of stagflation will not be far from the market's mind."

Exports declined at a 1.2 per cent rate in the first quarter - a sharp reversal from the fourth quarter's 10.6 per cent advance, and the first decline since 2003 - and there was unexpected weakness in government spending. Companies were also building up inventories at a slower pace than forecast, although business investment showed some resilience, with spending up at a 2 per cent rate, partly recovering from a 3.1 per cent decline in the closing quarter of 2006.