WASHINGTON – The nation’s economy probably gained speed during the first three months of the year as government spending rebounded following a damaging federal shutdown, though experts predict this improvement may be temporary as Middle East conflicts drive up fuel costs and strain family budgets.
The expected boost in the nation’s gross domestic product during this period would also stem from strong business investment in equipment, driven by artificial intelligence spending surges and data center construction supporting new technology.
However, the Commerce Department’s initial first-quarter GDP report scheduled for Thursday is anticipated to reveal that consumer spending continued to weaken even before the U.S.-Israeli conflict with Iran pushed average American gasoline prices above $4 per gallon.
“We remain in relatively slow growth mode, nothing exciting,” explained Brian Bethune, an economics professor at Boston College. “There’s nothing really to get a good fire going. There are some warm embers, but there is no fire out there.”
Economists surveyed by Reuters predict GDP expanded at a 2.3% annual rate during the quarter, with projections ranging from a 0.2% decline to 3.9% growth.
The survey concluded before Wednesday’s data revealed that non-defense capital goods orders excluding aircraft – a key indicator of business spending – surged 3.3% in March. This increase was somewhat offset by a significant expansion in the goods trade deficit due to imports, though some products were stored in business warehouses.
Economic expansion decelerated to just 0.5% during the October-December period. Reduced federal government spending cut 1.16 percentage points from growth, the largest such reduction since early 1994.
Economists anticipated a partial recovery, estimating that overall government spending contributed at least one full percentage point to GDP growth last quarter. They believe this moderate expansion rate would allow the Federal Reserve to maintain current interest rates, potentially through 2027, assuming no labor market deterioration.
The central bank on Wednesday maintained its key overnight interest rate between 3.50%-3.75%, citing growing inflation concerns.
“In the current environment they don’t need to do anything right now to support the labor market,” stated Gus Faucher, chief economist at PNC Financial. “They can keep rates where they are through the rest of 2026 and into 2027 until we get a better picture of what happens with the situation in Iran and energy prices and what’s happening with the labor market.”
Job creation averaged 68,000 positions monthly in the first quarter compared to 20,000 during the same period last year. The employment market has cooled considerably from 2023 and 2024, with some economists attributing this to President Donald Trump’s trade and immigration policies, which they say reduced both labor demand and worker supply.
The softer job market has slowed wage increases. Import taxes have raised prices on certain goods, though the impact on official inflation measurements has been relatively modest. Economists note that consumers have drawn on savings or reduced their saving rates to maintain spending levels, a pattern they say cannot persist indefinitely. The savings rate stood at 4.0% in February.
Consumer spending, representing over two-thirds of economic activity, is expected to have slowed further from the fourth quarter’s 1.9% growth rate. A Reuters survey projected the Personal Consumption Expenditures Price Index rose at a 3.8% rate last quarter after increasing 2.9% in the fourth quarter. This index serves as one of the Federal Reserve’s key inflation measures for its 2% target.
Higher inflation could diminish some expected benefits from tax reductions, economists cautioned. The boost from larger tax refunds is expected to disappear soon, leading to what they predict will be weaker spending this year.
“The saving rate went down to support consumer spending and I don’t think it’s going to go down any further,” said Boston College’s Bethune. “With the increase in inflation, real wages are pretty much flat… There’s nothing here that is going to propel consumer spending meaningfully.”
Double-digit growth is expected for business equipment spending, compensating for reduced consumer activity. However, beyond AI-related investments, business spending was likely less impressive due to continued weakness in non-residential construction like factories.
The AI investment surge is increasing imports, expanding the trade deficit that probably reduced GDP growth last quarter. With some imports accumulating in warehouses due to slower consumer spending, the negative impact was likely reduced by inventory buildup.
Housing investment is expected to have declined for a fifth consecutive quarter as elevated mortgage rates continue hampering the real estate market. Economists predict Middle East conflicts will burden economic growth starting in the second quarter.
“We see the conflict’s drag on the economy peaking in the second quarter, with consumer discretionary spending among the most adversely impacted,” said Oren Klachkin, financial market economist at Nationwide. “There is a risk the damage could spill over into the second half of the year.”
