WASHINGTON (Reuters) - The economy unexpectedly contracted in the fourth quarter, but analysts said there was no reason for panic given that consumer spending and business investment picked up.
Gross domestic product fell at a 0.1 percent annual rate, its weakest performance since it emerged from recession in 2009, the Commerce Department said on Wednesday.
If it were not for the hit from slower inventory growth and the deepest plunge in defense spending in 40 years, the economy would have grown at a respectable 2.5 percent rate.
"Obviously, the headline number is a bit jarring, but the underlying details of the report, by and large, are consistent with an economy that is growing probably at a trend basis of about two percent," Michael Hanson, a senior economist at Bank of America Merrill Lynch in New York.
Economists polled by Reuters had expected GDP to rise at a 1.1 percent rate and none had predicted a contraction.
U.S. financial markets largely shrugged off the data, heartened by the acceleration in consumer spending and the rebound in business investment, which pointed to some fundamental economic strength.
Inventories and the defense-led drop in government spending sliced 2.6 percentage points from growth, a weight that was expected to lessen in the first three months of this year.
A second report from payroll processor ADP showed private-sector payrolls expanded by 192,000 jobs in January after increasing 185,000 in December.
Faster employment growth could help the economy to weather the headwind of higher taxes and possible spending cuts this year. A payroll tax cut expired on January 1 and big automatic spending cuts are set to take hold in March unless Congress acts.
The data was published as officials at the Federal Reserve prepared to wrap up a two-day meeting. The report will likely provide ammunition for officials at the U.S. central bank to stay on their ultra-accommodative policy stance.
Economists say a growth pace in excess of 3 percent would be needed over a sustained period to significantly lower high unemployment. For the whole of 2012 the economy grew 2.2 percent, and a report on Friday is expected to show the jobless rate held at 7.8 percent for a third straight month in January.
The economy was slammed by a monster storm in late October, which caused extensive damage along the East Coast. The Commerce Department estimated the damage from the storm at about $44.4 billion. Economists said that could have cut around 0.5 percentage point off fourth-quarter growth.
The recovery also had to deal with uncertainty over the so-called fiscal cliff of scheduled tax hikes and budget cuts, which hurt confidence even though households and businesses seemed to largely shrug off the worries.
Businesses, caught with too much inventory on their hands in the third quarter, slowed their stock building in the final three months of the year. That slowdown reduced GDP growth by 1.27 percentage points, the most in two years.
But with the pick-up in consumer spending in the fourth quarter, businesses now will need to replenish stocks, which should help lift growth early this year.
"Today's number actually leaves the economy relatively well-positioned heading into the first quarter," said Michael Feroli, an economist at JPMorgan in New York.
"The slowing in the pace of inventory accumulation means that businesses will not have to pull back on production as much in the first quarter if consumer spending does downshift in response to the recent tax increases."
Many forecasters think the economy will grow only around a 1 percent pace in the first quarter but then strengthen as the year progresses.
The GDP report showed government spending tumbled at a 6.6 percent rate, with defense outlays plunging at a 22.2 percent pace, the largest drop since the third quarter of 1972.
Trade also cut into the economy, slicing a quarter of a percentage point off the change in GDP. Exports, which have been hampered by a recession in Europe, a cooling Chinese economy and storm and strike-related port disruptions, fell for the first time since the first quarter of 2009.
Caterpillar Inc, the world's largest maker of construction equipment, reported a sharp drop in quarterly profits, citing weak demand in China as one reason for the decline.
PLENTY OF POSITIVES
In one bright spot, the report showed that income available to households after taxes and inflation increased at a strong 6.8 percent rate in the fourth quarter.
That and a slower pace of inflation allowed households to step up their savings, and the saving rate rose by more than a percentage point.
A price gauge in the report advanced at just a 1.2 percent pace, down from 1.6 percent in the third quarter. So-called core prices increase just 0.9 percent, the smallest gain in two years.
Consumer spending, which accounts for more than two-thirds of economic activity, rose at a 2.2 percent rate, accelerating from the prior quarter's 1.6 percent growth pace, while business investment rebounded after its first drop in 1-1/2 years.
The housing market was another positive.
Residential construction grew at a 15.3 percent rate after notching a 13.5 percent growth pace in the third quarter, and homebuilding added to growth last year for the first time since 2005.
"A turnaround in the housing market will be a key support to the economy this year, with homebuilding contributing to growth and higher home prices supporting consumer spending," said Stuart Hoffman, chief economist at PNC Financial in Pittsburgh.
(Additional reporting by Leah Schnurr in New York, editing by Andrea Ricci)
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