Business Spending Propels Recovery

By SUDEEP REDDY

The U.S. economy grew at a slower pace in the first quarter, but the underlying trends—including a bigger share of growth from industry, strong consumer spending and low inflation—were encouraging.

The nation's gross domestic product, the value of all goods and services produced, grew at an annual rate of 3.2% after climbing 5.6% in the fourth quarter, the Commerce Department said Friday.

That's not nearly fast enough to bring down stubbornly high unemployment. In addition, threats ranging from turmoil in Europe to the difficulty smaller businesses face in borrowing money are clouding the prospects for continued recovery.

Spending by consumers rose at a 3.6% rate, more than double the fourth-quarter pace and faster than any quarter in the past three years. But half the quarter's growth came from firms rebuilding inventories.

"The strength and durability of this recovery remain in question, as the economy sails into strong headwinds over the next few quarters," said Bart van Ark, chief economist of the Conference Board, a business research group. Markets were disappointed by the report, among other things. The Dow Jones Industrial Average closed down 1.42% to 11008.61.

One big question is whether consumers will keep loosening their purse strings. Consumer spending accounts for about 70% of the demand in the economy. Consumer confidence has improved quite a bit from the lows of the financial crisis, but remains depressed. The University of Michigan's consumer sentiment index, released Friday, dropped slightly to 72.2 in April from 73.6 in March—and was well below the pre-recession levels, which exceeded 90.

Tiffany Luongo, a commercial real-estate broker in Fort Myers, Fla., who saw her income drop 90% during the depths of the downturn, is among the cautious ones. "Even though things have gotten dramatically better, I don't think I'll spend as freely as I once did," she said.

Business is picking up, and Ms. Luongo is dining out more often and taking "a few little splurges," like buying a new suit for work. But she continues to hold spending down, getting her nails done less often, for instance, and switching to a hair salon that costs her $35 a month rather than the $180 she used to spend. A few weeks ago, she shopped at a dollar store for the first time to buy household items like cleaning supplies and toothpaste. "I really appreciate the lessons I've learned," said Ms. Luongo, 44 years old. "I feel almost nostalgic. I'm living more like my parents did, being more careful with money."

Companies that sell to consumers see signs of hope but remain cautious. VF Corp., maker of Lee and Wrangler jeans, said Friday its first-quarter profit rose 62% from a year earlier—after cutting costs and reducing inventory. "Consumers were more engaged in the economy and in buying apparel" during the first quarter, said Chief Executive Eric Wiseman. But he warned that "the economic recovery remains fragile."

More customers at the 400 stores operated by Build-A-Bear Workshop Inc., a retailer that lets customers make stuffed animals, pushed revenue up almost 4% from a year earlier. "We're benefiting…because the customer is feeling a little bit better, needing to get out and shop and buy some new things," said Tina Klocke, an executive at the firm.

Friday's data showed inflation remains tame, even as the economy climbs out of recession. The Federal Reserve's preferred gauge, the price index for personal consumption expenditures excluding food and energy, rose an annualized 0.6% in the first quarter, compared with the fourth quarter's 1.8%. Wages aren't rising much either. The Labor Department's employment cost index, the broadest measure of wages and benefits, rose 0.6% in the first quarter from the fourth, and was 1.7% higher than a year earlier.

Business spending is improving, but many businesses are bracing for a slow expansion. Dunbar Armored Inc. of Hunt Valley, Md., which uses 1,500 red trucks to transport money for retailers and restaurants, froze wages last year for the first time since the early 1970s recession. The firm installed new electronic tracking devices to improve its efficiency, cutting labor costs by more than 5%, as it faced price cuts by competitors. Its 5,200 employees were told in April they would receive 2% to 4% pay increases as business picks up. "We're seeing things moving in a better way," said CEO Kevin Dunbar.

Dunbar Armored is hauling 6% more money so far this year, a sign of higher spending at retailers and expansion at some. "It's not like it was four or five years ago or in the 1990s, but I'm cautiously optimistic," Mr. Dunbar said. "It's kicking in the right direction."

But the new data highlighted numerous risks. Residential investment dropped at a 10.9% annual rate during the quarter. Commercial construction fell 14%, even as businesses ramped up their spending on equipment and software. Exports also failed to keep up with imports, damping hope that a major ramp-up in exports by U.S. producers can offset weakness elsewhere in the economy. And while federal stimulus dollars were still boosting the economy during the quarter, that was offset by a decline in spending by state and local governments.

For all those reasons, economists continue to worry about the recovery in the second half of the year as the boost from inventory restocking and fiscal stimulus wanes.

"We know that economic recoveries in the wake of financial crises tend to be unusually modest," said economist Paul Ashworth of Capital Economics. "They don't tend to be super-sharp, V-shaped recoveries where we get 8% GDP growth."

And even when the economy returns to something approaching normal, the lingering effects of recession, widespread unemployment and changes in the world economy will remain.

"Even on optimistic assumptions, there is going to be substantial unused capacity in this economy," White House economic adviser Lawrence Summer said Friday. He noted one in five men between ages 25 and 54 was unemployed. Even if the economy returns to full employment in five years, he predicted, one in six wouldn't be working.

Write to Sudeep Reddy at sudeep.reddy@wsj.com