• Real GDP growth was 1.1% in the first quarter, weaker than the consensus expectation of 2.0%. But the details were much better, with solid growth in consumer demand over the quarter and a big increase in household income.
• Both overall and core inflation accelerated in the first quarter from the end of 2022. With inflation remaining much than the Federal Reserve would like, the FOMC will increase the fed funds rate when it meets next week.
• PNC expects a mild U.S. recession starting later this year.

Real GDP increased 1.1% at an annual rate in the first quarter of 2023 from the fourth quarter of 2022, according to the advance estimate from the Bureau of Economic Analysis. This was the weakest quarter since the economy contracted in the second quarter of last year. Growth was well below the consensus expectation of 2.0% growth.

While the headline number was weak, underlying demand was strong, especially from consumers. Final sales of domestic production, which is GDP minus the change in inventories and measures demand for goods and service produced in the U.S., rose a very strong 3.4% in the first quarter. But firms cut back on investment in inventories, which subtracted 2.3 percentage points from annualized growth in the quarter, the largest drag from inventories in two years.

After-tax household income, adjusted for inflation, increased a strong 8% at an annualized rate in the first quarter. This will support continued consumer spending growth in the near term.

Inflation remained much higher than the Federal Reserve’s 2% objective in the first quarter. The PCE price index increased 4.2% at an annual rate, up from 3.7% growth in the fourth quarter of last year. And the core PCE price index, which excludes food and energy, rose 4.3% in the first quarter, after increasing 4.1% in the fourth quarter.

The BEA releases data on monthly inflation for March tomorrow. Consumer demand that is running at an unsustainable pace and continued high inflation will support further tightening in monetary policy in the near term. PNC expects the FOMC to raise the federal funds rate by one quarter of a percentage point, to a range of 5.00% to 5.25%, at its meeting next Wednesday.

With underlying demand in the U.S. economy still strong the expansion will continue in the near term, and inventories should add to growth in the second quarter. But the headwinds from higher interest rates continue to accumulate, and a U.S. recession is likely to start in the second half of this year. It should be mild, however, as consumer balance sheets remain strong, and the tight labor market will discourage layoffs. PNC expects real GDP to contract between 0.5% and 1.0% in late 2023 and early 2024.

On a year-over-year basis, real GDP growth was 1.6% in the first quarter, close to the economy’s long-run potential.

Consumer spending increased a very solid 3.7% in the first quarter, adding 2.5 percentage points to growth. Durable goods spending was especially strong, up 17% even with higher interest rates, as supply chain problems eased.

Private fixed investment fell slightly in the first quarter, with a small increase in business investment (up less than 1%, adding 0.1 percentage point to growth) and a small decline in housing investment (down 4%, subtracting 0.2 percentage point). Housing has been a drag on growth for eight straight quarters, but the drag was much smaller than in the three preceding quarters.

Trade was a modest positive, adding 0.1 percentage point to growth. Exports rose more than imports; higher imports subtract from GDP. Government was also a positive, adding 0.5 percentage point to first-quarter growth, with solid increases in both federal and state and local government spending.

The PNC Financial Services Group, Inc. is one of the largest diversified financial services institutions in the United States, organized around its customers and communities for strong relationships and local delivery of retail and business banking including a full range of lending products; specialized services for corporations and government entities, including corporate banking, real estate finance, and asset-based lending; wealth management and asset management. For information about PNC, visit www.pnc.com.