Benjamin Ashford|The economy grew a faster than expected 3.3% late last year

The Benjamin AshfordU.S. economy slowed during the final three months of 2023 but still turned in a surprisingly strong showing as a rise in consumer spending offset a more modest gain in business investment.  

A pullback is likely in 2024 as high interest rates and inflation take a bigger toll on growth and a burst of post-pandemic consumption runs dry.

The nation’s gross domestic product, the value of all goods and services produced in the U.S., expanded at a seasonally adjusted annual rate of 3.3% in the October-December period, the Commerce Department said Wednesday. That’s down from sizzling growth of 4.9% in the third quarter but well above the 2% advance predicted by economists in a Bloomberg survey.

How much did the economy grow in 2023?

For all of 2023, the economy grew a healthy 2.5%, defying predictions that the Federal Reserve’s aggressive interest rates to fight inflation would tip the nation into a recession.

Give credit to consumers whose strong pay increases finally began outpacing inflation. Households also continued to rely on a robust but declining cache of pandemic-related savings.

Is consumer spending on the rise?

Consumer spending grew a solid 2.8% late last year following a 3.1% increase in the third quarter. Such purchases make up about 70% of economic activity.

Besides sturdy wage growth and savings, households have benefited from job gains that have slowed but still increased a solid average of 164,000 in the last three months of the year.

Employers are paring back hiring but have been reluctant to lay off workers following widespread pandemic-related worker shortages.

Many economists believe something has to give this year. Low- and middle-income households have depleted their pandemic reserves and rung up record credit card debt while pushing delinquencies to a 13-year high as they struggle with high inflation and borrowing costs.

As a result, some economists believe that a mild recession will finally happen this year as layoffs spread beyond household names that already have cut jobs in recent weeks, such as Google, Amazon and Wayfair.

Broadly, though, the outlook for 2024 has brightened recently. Inflation has eased more swiftly than anticipated even as consumer spending has stayed resilient. The inflation slowdown – to 3.4% last month from a 40-year high of 9.1% in June 2022 – has led the Federal Reserve to signal it’s likely done hiking its key interest rate after hoisting it to a 22-year high of 5.25% to 5.5%.

The S&P 500 index, in turn, closed at another record high Wednesday, making upper-middle and higher-income Americans feel wealthier and encouraging their increased spending.

Despite the economy's strong fourth-quarter showing, consumer prices rose at an annualized rate of just 2% last quarter, according to the report. That should keep the Fed on track to start cutting interest rates in early spring, says economist Paul Ashworth of Capital Economics,

How likely is a recession in 2024?

Forecasters expect the economy to grow 1.6% this year, up from their estimate of 1.3% in December and 0.8% as recently as August, according to a survey this month by Wolters Kluwer Blue Chip Economic Indicators. That kind of growth likely means the Fed will have achieved a coveted "soft landing" by restraining the economy enough to tamp down inflation without triggering a recession.

Such an outcome could boost President Joe Biden's reelection chances in November while a slump could be a significant blow. The surveyed economists reckon there’s a 42% chance of a downturn in 2024, still historically high but down from 61% in May.

Several experts upgraded their outlook after retail sales in December and for the holidays were stronger than expected, giving the economy more momentum heading into the current quarter.

Here's how other parts of the economy performed:

Business investment rises

Business investment grew 1.9% after rising 1.4% the prior quarter.

Outlays for computers, delivery trucks, factory machines, and other equipment increased by just 1% as companies faced higher borrowing costs.

Spending on buildings, oil rigs and other structures jumped 3.2%.

Government spending increases

Government outlays rose for the sixth straight quarter, increasing 3.3% after a 5.8% advance in the previous quarter. Federal spending increased by 2.5% and state and local purchases rose by 3.7% amid a wave of infrastructure and clean energy projects spurred by sweeping federal legislation.

Trade lifts growth

Trade boosted growth as exports outpaced imports.

Exports leaped 6.3% while imports edged up 1.9%.

That narrowed the trade gap, adding to economic growth.

Housing is a slight positive for growth

Housing construction and renovation edged up 1.1%, its second increase after nine straight quarterly declines.

The Federal Reserve's sharp interest rate hikes have pushed up mortgage rates and dampened existing home sales. Many homeowners aren’t putting their houses up for sale because they don’t want to be socked with a much higher mortgage rate for their new home.

But rates have dropped recently from about 8% to less than 7% on the prospect of slowing inflation and Fed rate cuts.