By Lucia Mutikani
WASHINGTON, April 30 (Reuters) – U.S. economic growth picked up in the first quarter as businesses boosted investment in artificial intelligence and government spending rebounded after a crippling shutdown, but the improvement is likely temporary, with the war with Iran raising inflation and eroding household purchasing power.
The Commerce Department’s advance estimate of gross domestic product on Thursday showed consumer spending, the economy’s main engine, losing further momentum last quarter even before the U.S.-Israeli conflict with Iran raised the average U.S. gasoline price to above $4 a gallon.
The pain at the pump was another blow for households, already burdened by high prices stemming from President Donald Trump’s tariffs, economists said. Inflation accelerated at its fastest pace in nearly four years in March.
Americans have grown frustrated with the rising cost of living, with most disapproving of Trump’s stewardship of the economy, a political risk for the Republican Party heading into congressional midterm elections in November.
“Amid some cooling in consumer spending, investment linked to tech and AI has clearly become the main engine of growth in the U.S.,” said James Knightley, chief international economist at ING.
Gross domestic product increased at a 2.0% annualized rate last quarter, the Commerce Department’s Bureau of Economic Analysis said. Economists polled by Reuters had forecast GDP growth increasing at a 2.3% annualized rate. Estimates ranged from a 0.2% pace of contraction to a 3.9% growth rate.
The economy grew at a 0.5% pace in the fourth quarter. The AI spending boom and the building of data centers underpinning the technology helped to lift business spending on equipment, which increased at a 17.2% rate after rising at a 4.3% pace in the fourth quarter. Spending on intellectual products increased at a 13% rate.
Government spending rebounded at a 4.4% pace, with federal outlays increasing at a 9.3% rate. Growth also received a boost from inventories, but the AI spending spree is pulling in imports, leading to a widening in the trade deficit that subtracted 1.30 percentage points from GDP growth last quarter.
Residential investment contracted for a fifth straight quarter as high mortgage rates continued to stifle the housing market. The strength in business investment helped to mitigate the slowdown in consumer spending, which increased at a 1.6% rate after advancing at a 1.9% pace in the fourth quarter.
U.S. stocks opened higher. The dollar fell against a basket of currencies. U.S. Treasury yields were lower.
LOW LAYOFFS ANCHORING LABOR MARKET
Though layoffs have remained low, with first-time applications for unemployment benefits last week dropping to the lowest level since 1969, employers have been hesitant to increase hiring because of lingering uncertainty from tariffs. Businesses face more uncertainty from the Middle East conflict, which is raising the prices of oil, fertilizers and other commodities that are shipped through the Strait of Hormuz.
The labor market has slowed significantly compared to 2023 and 2024, with economists also pointing to the Trump administration’s immigration policy, which they said had reduced the supply of workers.
Softening labor market conditions have curbed wage growth. Wages and salaries increased 3.4% in the 12 months through March, a report from the Labor Department showed. Adjusted for inflation, wages rose only 0.1% during that period. Consumers have relied on savings or have been saving less to maintain their spending, which economists said could not continue indefinitely.
The saving rate dropped to 3.6% in March, the lowest level since October 2022. Higher inflation could offset some of the anticipated stimulus from tax cuts, economists warned. The boost from larger tax refunds was expected to fade soon, leading to what they said would be weaker spending this year.
Despite the moderation in consumer spending, the pace was sufficient to help underpin the economy. A measure of domestic demand that excludes government spending, inventories and trade, increased at a solid 2.5% pace last quarter after rising at a 1.8% rate in the October-December quarter.
That, combined with labor market stability, supported financial market expectations that the Federal Reserve will hold interest rates steady, possibly into 2027. The U.S. central bank on Wednesday left its benchmark overnight interest rate in the 3.50%-3.75% range, noting rising concerns about inflation.
Economists expect the war in the Middle East to weigh on economic growth from the second quarter.
(Reporting by Lucia Mutikani; Editing by Paul Simao, Chizu Nomiyama and Andrea Ricci )
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