U.S. economy returned to growth last quarter, expanding 2.6%

The U.S. economy grew at a better-than-expected 2.6% annual rate from July through September, snapping two straight quarters of economic contraction and overcoming punishingly high inflation and interest rates.

Thursday’s estimate from the Commerce Department showed that the nation’s gross domestic product—the broadest gauge of economic output—grew in the third quarter after having shrunk in the first half of 2022. Stronger exports and steady consumer spending, backed by a healthy job market, helped restore growth to the world’s biggest economy.

The latest GDP report comes as Americans, worried about inflation and the risk of a recession, have begun to vote in midterm elections that will determine whether President Joe Biden’s Democratic Party retains control of Congress. Inflation has become a signature issue for Republican attacks on the Democrats’ stewardship of the economy.

Consumer spending, which accounts for about 70% of U.S. economic activity, expanded at a 1.4% annual pace in the July-September quarter, down from a 2% rate from April through June. Last quarter’s growth also got a big boost from exports, which shot up at an annual pace of 14.4%. Government spending also helped: It rose at a 2.4% annual pace, the first such increase since early last year, with sharply higher defense spending leading the way.

Housing investment, though, plunged at a 26% annual pace, hammered by surging mortgage rates as the Federal Reserve aggressively raises borrowing costs to combat chronic inflation. It was the sixth straight quarterly drop in residential investment.

Overall, the outlook for the overall economy has darkened. The Fed has raised interest rates five times this year and is set to do so again next week and in December. Chair Jerome Powell has warned that the Fed’s hikes will bring “pain” in the form of higher unemployment. Concern about the likelihood of a recession next year has been growing.

“Looking ahead, risks are to the downside, to consumption in particular, as households continue to face challenges from high prices and likely slower job growth going forward,’’ Rubeela Farooqi, chief U.S. economist at High Frequency Economics, wrote in a research note.

With inflation still near a 40-year high, steady price spikes have been pressuring households across the country. At the same time, rising interest rates have derailed the housing market and are likely to inflict broader damage over time. The outlook for the world economy, too, grows bleaker the longer that Russia’s war against Ukraine drags on.

Economists noted that the third-quarter gain in GDP could be traced entirely to the surge in exports, which added 2.7 percentage points to the economy’s expansion. Export growth will be difficult to sustain as the global economy weakens and a strong U.S. dollar makes American products pricier in foreign markets.

Thursday’s report offered some encouraging news on inflation. A price index in the GDP data rose at a 4.1% annual rate from July through September, down from 9% in the April-June period—less than economists had expected and the smallest increase since the final three months of 2020. That figure could raise hopes that the Fed might decide it can soon slow its rate hikes.

Last quarter’s U.S. economic growth reversed annual declines of 1.6% from January through March and 0.6% from April through June. Consecutive quarters of declining economic output are one informal definition of a recession. But most economists have said they believe the economy skirted a recession, noting the still-resilient job market and steady spending by consumers. Most of them have expressed concern, though, that a recession is likely next year as the Fed steadily tightens credit.

Preston Caldwell, head of U.S. economics for the financial services firm Morningstar, noted that the economy’s contraction in the first half of the year was caused largely by factors that don’t reflect its underlying health and so “very likely did not constitute a genuine economic slowdown.” He pointed, for example, to a drop in business inventories, a cyclical event that tends to reverse itself over time.

Higher borrowing costs have weakened the home market, in particular. The average rate on a 30-year fixed-rate mortgage, just 3.09% a year ago, is approaching 7%. Sales of existing homes have fallen for eight straight months. Construction of new homes is down nearly 8% from a year ago.

Still, the economy retains pockets of strength. One is the vitally important job market. Employers have added an average of 420,000 jobs a month this year, putting 2022 on track to be the second-best year for job creation (behind 2021) in Labor Department records going back to 1940. The unemployment rate was 3.5% last month, matching a half-century low.

Hiring has been decelerating, though. In September, the economy added 263,000 jobs—solid but the lowest total since April 2021.

International events are causing further concerns. Russia’s invasion of Ukraine has disrupted trade and raised prices of energy and food, creating a crisis for poor countries. The International Monetary Fund, citing the war, this month downgraded its outlook for the world economy in 2023.

Earlier story:

The problems have hardly gone away. Inflation, still near a 40-year high, is punishing households. Rising interest rates have derailed the housing market and threaten to inflict broader damage. And the outlook for the world economy grows bleaker the longer that Russia’s war against Ukraine drags on.

But for now anyway, the U.S. economy has likely returned to growth after having shrunk in each of the first two quarters of 2022.

At least that’s what economists expect to see Thursday when the Commerce Department issues its first of three estimates of gross domestic product—the broadest measure of economic output—for the July-September period.

Economists surveyed by the data firm FactSet have predicted, on average, that GDP grew at a 2% annual rate in the third quarter. That would reverse annual declines of 1.6% from January through March and 0.6% from April through June.

Consecutive quarters of declining economic output are one informal definition of a recession. But most economists say they believe the economy has so far skirted a recession, noting the still-resilient job market and steady spending by consumers. Most of them have expressed concern, though, that a recession is likely next year as the Federal Reserve continues to steadily ratchet up interest rates to fight inflation.

Preston Caldwell, head of U.S. economics for the financial services firm Morningstar, notes that the economy’s contraction in the first half of the year was caused largely by factors that don’t reflect its underlying health and so “very likely did not constitute a genuine economic slowdown.” He pointed, for example, to a drop in business inventories, a cyclical event that tends to reverse itself and generally doesn’t reflect the state of the economy.

By contrast, consumer spending, fueled by a healthy job market, and stronger U.S. exports likely restored the world’s biggest economy to growth last quarter.

Thursday’s report from the government comes as Americans, worried about high prices and recession risks, are preparing to vote in midterm elections that will determine whether President Joe Biden’s Democratic Party retains control of Congress. Inflation has become a signature issue for Republican attacks on the Democrats’ stewardship of the economy.

The risk of an economic downturn next year remains elevated as the Fed keeps raising rates aggressively to try to tame stubbornly high consumer prices. The central bank has raised its benchmark short-term rate five times this year, and it’s expected to announce further hikes next week and again in December. Chair Jerome Powell has warned bluntly that taming inflation will “bring some pain’’—namely, higher unemployment and, possibly, a recession.

Higher borrowing costs have already hammered the home market. The average rate on a 30-year fixed-rate mortgage, just 3.09% a year ago, is approaching 7%. Sales of existing homes have fallen for eight straight months. Construction of new homes is down nearly 8% from a year ago.

Still, the economy retains pockets of strength. One is the vitally important job market. Employers have added an average of 420,000 jobs a month this year, putting 2022 on track to be the second-best year for job creation (behind 2021) in Labor Department records going back to 1940. The unemployment rate was 3.5% last month, matching a half-century low.

But hiring has been decelerating. In September, the economy added 263,000 jobs—solid but the lowest total since April 2021.

International events are causing further concerns. Russia’s invasion of Ukraine has disrupted trade and raised prices of energy and food, creating a crisis for poor countries. The International Monetary Fund, citing the war, this month downgraded its outlook for the world economy in 2023.