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US Economy Shrinks For First Time In Three Years

(c) Sky News 2013

The US economy shrank in the last quarter of 2012, the first contraction in more than three years.

The Commerce Department said the economy shrank at an annual rate of 0.1% in the fourth quarter.

It was a stark contrast to the 3.1% growth rate recorded during the July-September quarter.

The deepest cuts in defence spending for 40 years, fewer exports and sluggish growth in company stockpiles have been blamed.

The surprise contraction could raise fears about the economy's ability to handle tax increases that took effect in January and more looming spending cuts.

"It represents a sharp turnaround from the 3.1% expansion seen in the third quarter and confounding economists, who had on average expected to see 1.1% growth," Markit chief economist Chris Williamson said.

"The contraction was the first since the second quarter of 2009."

Some believe the weakness may be because of one-time factors as government spending cuts and slower inventory growth subtracted a total of 2.6 percentage points from growth.

Those volatile categories offset faster growth in consumer spending, business investment and housing - the US economy's traditional core drivers of growth.

For all of 2012, the economy expanded at the rate of 2.2%, slightly up on 2011's 1.8%.

However, the economy may continue to stay weak in early 2013 as Americans come to grips with an increase in social security taxes that has left them with less take-home pay.

Subpar growth has held back hiring as the economy has only created about 150,000 jobs a month, on average, for the past two years.

That level of increase is barely enough to reduce the unemployment rate, which has remained at 7.8% for the past two months.

Economists have forecast little change in the unemployment rate when the government releases the January jobs report on Friday.

"The details of the decline suggest that the underlying performance of the US economy is far better than the headline number suggests," Mr Williamson added.

"In particular, companies sought to cut inventories which had built up in previous months, and if the stock reduction is excluded, the economy grew at a 1.1% annualised rate.

"After a disappointing end to 2012, the first quarter of 2013 may well surprise on the upside as the economy rebounds from a temporary spell of weakness."

Companies frequently cut back on inventories if they anticipate a slowdown in sales. This in turn means factories are likely to produce less.

US economists are now waiting to see the reaction of consumers to the expiration of the social security tax cut.

Congress and the White House allowed the temporary tax cut to end in January, but reached a deal to stop income taxes from rising for most Americans.

The tax increase will lower take-home pay this year by about 2%. It means a household earning $50,000 a year will have about $1,000 less to spend, while a household with two high-paid workers will have up to $4,500 less.