By Chris Cermak

WASHINGTON (MNI) – Consumer spending may have been the biggest
contribution to third-quarter growth in the United States, but the
sustainability of that high demand is also the most contentious element
of the growth outlook going forward.

Household spending climbed 2.4% in Q3, up from 0.7% in Q2 — adding
1.7 percentage points to overall GDP growth of 2.5% in the last quarter
— according to Thursday’s advance estimate by the Commerce Department’s
Bureau of Economic Analysis.

Demand held up despite a decline in consumer confidence through the
Washington debt ceiling dispute and a European debt crisis that dogged
investors over the summer months. The strong demand apparently surprised
businesses, which held inventories relatively flat over the quarter.
Inventories subtracted 1.1 percentage points from Q3 GDP.

The rise in demand also came despite falling inflation-adjusted
incomes. Real disposable income declined 1.7% over the same three-month
period, the largest drop in two years. The savings rate decelerated
to 4.1%.

The key question for economists going forward is how consumers and
businesses react to that divergence. Do households cut back spending or
will businesses ramp up production to meet the higher demand?

Russell Price, senior economist with Ameriprise Financial, is
hopeful that Q3 could mark the start of a positive feedback loop. Higher
demand will encourage businesses to beef up inventories and hire more
workers, pushing up real disposable income and further strengthening
consumer spending, though perhaps not at the 2.4% level seen in Q3.

“Businesses were concerned about a potential reduction in consumer
demand that never really materialized,” Price told Market News
International. “The consumer is spending and businesses are now starting
to up their production schedules … as the prior slowdown is being
reversed.”

Price points to encouraging underlying data on retail sales, autos
and other measures in October. Barclays also notes that rebounding auto
markets after the Japanese earthquake were not the chief reason for
strong third-quarter demand, another factor that bodes well for Q4
growth.

“A boost from autos and stronger real incomes should support a
further solid (if unspectacular) increase in real consumer spending in
Q4,” Barclays said in a note following the GDP release.

Other economists are less convinced that strong demand will hold
up. One drag could be the higher-than-usual Q3 demand for services,
which is notoriously difficult for the Bureau of Economic Analysis to
measure. Spending on services climbed 3%, the most since Q2 of 2005.

“The 2.4% headline consumer spending growth is simply not
sustainable,” Robert Dye, chief economist with Comerica, told MNI. The
high demand for services “looks a little hot to me.”

While the Q3 GDP report was encouraging, “it really doesn’t counter
a couple of fundamental drags that the economy” endures from weak labor
and housing markets, Dye says. Personal income could rebound slightly in
Q4, but is unlikely to rise sharply “unless we see a rapid acceleration
in wage and job growth.”

The latest jobless claims data from Thursday confirmed that labor
markets remain sluggish. Initial claims came in at 402,000 and the
four-week moving average rose to 406,000. U.S. administration officials
also acknowledge it will take above-trend GDP growth to push firms to
boost hiring.

“While the continued expansion is encouraging, faster growth
clearly is needed to replace the jobs lost in the recent downturn and to
reduce long-term unemployment,” Katharine Abraham of the White House
Council of Economic Advisers wrote in a blog post.

All this means the U.S. economic outlook remains highly uncertain.
While the latest GDP numbers may have eased fears of a recession in the
near term, the prospects for the economy going into 2012 are still very
much up in the air.

“I still do think that the odds of a recession are uncomfortably
high,” says Dye.

— Chris Cermak is a Washington reporter with Need to Know News

** Market News International Washington Bureau: 202-371-2121 **

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