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Blow for America's hopes of recovery as growth slows

This article is more than 17 years old
· Disappointing data may tempt Fed to cut rates
· Fears that house prices have a long way to fall

Growth in the US economy unexpectedly plummeted in the third quarter of this year to the slowest rate for over three years, driven by a weakening housing market, official figures showed yesterday.

The disappointing data from the commerce department sparked speculation among analysts that the Federal Reserve might be tempted into cutting interest rates before too long.

The economy expanded at an annualised rate of only 1.6% during the third quarter, down from 2.6% in the previous three months. This was the weakest rate since the first quarter of 2003, when growth was 1.2%.

Wall Street economists had forecast growth of 2.2%, but while the extent of the slowdown surprised markets, many analysts had expected the softening housing market to have a significant impact on the economy.

New house building dropped by 17.4% on the year during the period, the biggest decline in 15½ years. This knocked 1.1% off overall growth adding to bad news from the National Association of Realtors which said that existing home sales fell in September for the sixth successive month.

Prices for existing homes also weakened by 2.2% on a year earlier, the second consecutive monthly fall - something that has not happened since 1990. "Below 2% growth is certainly a negative surprise and suggests that the economy is cooling off faster than anticipated," said Michael Woolfolk, strategist at the Bank of New York. "But it is in line with the Federal Reserve's story that a moderation in growth will help core inflation come back down into its comfort zone in the mid-term and hence they need not make any changes to monetary policy, certainly not a rate hike."

Modest business spending on stocks rose at a $50.7bn (£26.7bn) annual rate, $3bn slower than in the second quarter, while the volume of imports more than tripled to a 7.8% annualised rate, which also dampened growth.

Meanwhile, consumer spending, which accounts for two-thirds of national economic activity, held up well, increasing at a rate of 3.1%, up from 2.6% in the second quarter. Exports and business investment were also robust, suggesting some parts of the world's largest economy remain in good shape. However, many economists said the worsening recession in the housing market still had a long way to go and it was only a matter of time before falling house prices had a negative impact on consumption.

The Fed kept interest rates on hold at 5.25% on Wednesday for the third time running, amid continued concerns over potential inflation pressures. However, the new data heightened expectations of a rate cut. "We had just pulled back from the idea that the next move was going to be a rate rise; that the Fed had its hands tied because of housing," said Marc Pado, analyst at Cantor Fitzgerald "This number really begs the question. Maybe the Fed will have to ease in the first quarter."

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