Economy logs brisk 3.9% annual growth

The U.S. economy grew at the fastest pace in 1-1/2 years in the third quarter as exports, consumer spending, business investment and defense outlays increased at a rapid clip even as the economy was being hit by turmoil in financial markets, the government said Wednesday.

But economists, including those at Global Insight, Moody's and Wachovia, say a number of headwinds — such as the housing slump, rising energy prices and a slowing job market — currently are acting as a hefty drag on the economy. That will lead to softer growth at the end of 2007 and into 2008 than that seen earlier this year.

Gross domestic product, the broadest measure of economic activity within the nation's borders, rose 3.9% at a seasonally adjusted annual rate in the July-September period, the Commerce Department said. That was slightly better than the 3.8% gain seen in the second quarter and was the fastest gain since the first quarter of 2006.

"This may have been the summer of the housing market's discontent, but it clearly wasn't for the rest of the economy," Joel Naroff, president of Naroff Economic Advisors in Holland, Pa., said in a note to clients.

The gains in the economy were fairly broad-based:

•Consumers, the main engine of the U.S. economy, increased their spending 3% in the third quarter, up from 1.4% in the second quarter.

•Businesses boosted investment 7.9% following an 11% surge.

•Exports rose 16.2% in the third quarter, more than double the rate of increase in the second quarter and the biggest gain in nearly four years. Exports of goods rose at the fastest pace in more than a decade, in part reflecting a weakened dollar, which makes U.S. goods cheaper to buyers abroad, and strength in the worldwide economy.

•Defense spending rose 9.7% last quarter, the biggest gain since the end of 2006, the government said.

Housing, however, continued to be a negative for the economy in the third quarter. Home-building fell for the seventh consecutive quarter in the July-September period and subtracted a full percentage point from GDP.

The severe drop in home construction is expected to continue to act as a drag on the economy in coming months. And a sharp decline in the overall housing market, including sales of previously owned homes and prices, will likely take some steam out of consumer spending in the months ahead.

Add in higher energy prices and a softening job market, and consumers are likely to tap on the brakes, but not stop spending entirely, says John Silvia, chief economist at Wachovia in Charlotte.

"I have to expect consumer spending is going to slow," he says. Silvia anticipates GDP in the fourth quarter will rise between 1.5%-2% and will continue to come in below 3% in the first half of 2008, in large part because of the expected softening in consumer spending.

In a survey of 53 economists conducted Oct. 18-24 by USA TODAY, the median forecast was for GDP of 1.7% in the fourth quarter, 2.2% in the first quarter and 2.4% in the second quarter.

In other positive news in the GDP report, the government said inflation remained largely contained in the third quarter. The Federal Reserve's preferred inflation gauge, which measures prices based on actual spending by and for consumers excluding food and energy, rose 1.8% in the third quarter, the Commerce Department said.

Although that was higher than the 1.4% recorded in the second quarter, it was still within the Fed's informal inflation comfort zone of 1%-2%.

A second report from the department showed construction spending rose 0.3% in September, the best showing in four months. All-time high spending in both commercial construction by private builders and government projects more than offset weakness in home building.

A report on the labor markets Wednesday said employers' costs to hire and retain workers grew at a slightly slower pace in the summer, suggesting that a somewhat softer — but still solid — jobs climate is easing inflation pressures. The Labor Department reported that compensation costs — including wages, salaries and benefits — rose 0.8% in the July-to-September quarter. That was down a bit from a 0.9% increase posted in the second quarter.