Economy Showing Strength in Early 2023 After Last Quarter’s GDP Gain Revised Modestly Lower

The downward revision primarily reflected slower consumer spending late last year than previously estimated.

Entering this year, forecasters had projected the economy to cool, but recent data shows a strong labor market and improved spending.

Worker claims for unemployment benefits, a proxy for layoffs, ticked down last week, the Labor Department said Thursday. Hiring accelerated last month and the unemployment rate fell to a 53-year low. Retail sales jumped 3% in January, reversing two consecutive months of decline, a separate Commerce Department report showed. Business activity, particularly in the services sector, picked up in February, according to surveys of manufacturers and service providers released Tuesday. 

Recent signs of strength could keep upward pressure on prices and complicate the Federal Reserve’s efforts to tame inflation.

“It’s still a rolling boil of an economy, that’s the challenge for the Fed, they’d like to see an economy that’s more tepid and comfortable than searing,” said KPMG chief economist

Diane Swonk.

In the latest GDP report, inflation was revised higher in the fourth quarter. The personal-consumption expenditures price index, the Fed’s preferred gauge, advanced at a seasonally adjusted annual rate of 3.7% from the prior quarter. That compared with an earlier reading of 3.2%. Core PCE, which strips out volatile food and energy costs, was revised up to 4.3% increase from an initial estimate of 3.9%. The Fed targets a 2% inflation rate. 

The Commerce Department is set to release January’s PCE price index on Friday. Economists surveyed by The Wall Street Journal estimate that core prices, which exclude volatile food and energy prices, rose a sturdy 0.5% in January from a month earlier.

Fed officials expect to keep raising rates this year, according to the minutes of their most recent gathering, released Wednesday. Officials approved raising their benchmark federal-funds rate by a quarter percentage point to the highest level since 2007.

Stronger economic activity and slower progress on inflation than previously expected could keep the Fed raising rates longer than anticipated before the recent reports. The Fed raises rates to fight inflation by slowing the economy through tighter financial conditions—such as higher borrowing costs, lower stock prices and a stronger dollar—that curb demand.

Oren Klachkin,

lead U.S. economist at Oxford Economics, said rate increases will tip the economy into recession this year, but that the downturn will be mild compared with previous recessions.

“While we continue to forecast a recession, we see risks that it may start later than we currently expect,” he said in a note to clients. 

Forecasting firm S&P Global Market Intelligence on Thursday estimated GDP would contract at a 0.7% rate in the first three months of the year.

“The economy is slowing,” investment firm Blackstone Inc.’s Chief Executive

Stephen Schwarzman

said at a conference last week. “When you have interest rates up, you should grow slower. And if inflation stays up, your business will have a margin squeeze, which is what’s happening.”

But recent readings suggest consumers are so far coping, but changing their behavior.

“The U.S. consumer has a very steady pulse, they’re looking healthy,” Visa Inc. Chief Financial Officer

Vasant Prabhu

said. “There’s a shift from people buying home improvement projects, clothes, to a lot more travel, entertainment and restaurant spending.”

The Federal Reserve Bank of New York last week said debt balances grew by the most in 20 years in the fourth quarter, driven by increasing mortgage and credit-card balances. The share of debt becoming delinquent also rose, after two years of historically low delinquency rates during the pandemic.

Last quarter, a buildup in inventories helped drive economic growth. Final sales to private domestic purchasers, a measure of consumer and business spending that gauges underlying demand in the economy, rose at a tepid 0.1% rate from October through December.

Stephen Stanley,

chief U.S. Economist at Santander U.S. Capital Markets, sees the inventory buildup unwinding early this year, which would lead to weaker overall economic growth.

Thursday’s GDP report showed consumer spending, which accounts for more than two-thirds of total economic output, rose at a 1.4% annual rate in the fourth quarter, revised down from a previous estimate of 2.1% growth. Americans pulled back on purchases of long-lasting durable goods, such as vehicles and appliances at the end of last year.

Consumers are spending more on food and less on electronics, apparel and home improvements as inflation and changing habits lower demand for many goods, two of the country’s largest retailers, Walmart Inc. and Home Depot Inc., reported this week.

Business investment cooled in the fourth quarter, with fixed nonresidential investment rising at a 3.3% annual rate, dragged down by lower investment on business equipment. A strong dollar and weak growth overseas hurt demand for American-made products, and exports declined at a 1.6% annual rate.

The housing sector was a headwind for growth as residential investment fell at a 25.9% annual pace in the fourth quarter, with demand for mortgages dented by higher borrowing costs.

Write to Harriet Torry at harriet.torry@wsj.com