US economy shrinks unexpectedly as defence spending falls sharply

The US economy shrank unexpectedly in the final quarter of 2012 as federal defence spending fell sharply and businesses cut their inventories, in a signal of the economic challenges facing the Obama administration.

In the first economic decline since the US recession ended in 2009 and in the aftermath of the financial crisis, gross domestic product fell by 0.1 per cent, the US commerce department said, when the market had expected a 1.1 per cent rise.

The new economic data is a setback for the White House and evidence of the uncertainty surrounding US fiscal policies, although the figures are expected to be revised significantly as further data becomes available in February and March.

Investors were spooked by the latest figures as European shares suffered their biggest daily drop this month. Shares on Wall Street and the value of the US dollar declined.

More upbeat statistics would suggest that the contraction could be a one-quarter bump on the road to recovery for the US economy as underlying growth in consumer and business spending remained reasonably strong.

Performing strongly

Personal consumer spending rose at a 2.2 per cent annual rate, while business spending on equipment and software rose at a strong rate of 12.4 per cent. Housing continued to perform strongly – investment in residential property rose 15.4 per cent for the seventh consecutive quarter. The US economy grew 2.2 per cent for 2012 as a whole, which was better than the 1.8 per cent annual growth rate in 2011.

Economists suggested the fourth-quarter figure should not be a cause of concern. The contraction was “a disconcerting headline number which masked better underlying performance of the economy”, said JP Morgan Chase economist Michael Feroli in a report.

Still, the negative figure will put pressure on Obama’s administration as unemployment remains at 7.8 per cent and the economy is only expected to grow slowly in coming months.

The effect of avoiding the so-called fiscal cliff – when automatic government spending cuts and tax rises were due to come into effect at year-end – was seen in a 6.8 per cent rise in disposable incomes.