The Bureau of Economic Analysis reported last Friday that the economy expanded at an annualized rate of 3.2 percent in the fourth quarter of 2010. The new findings offer further confirmation that private sector activity has been increasing, even though job growth remains exceptionally weak and in contrast with earlier fears that the country might fall back into recession as stimulus spending tapered off in the second half of last year.

Apart from the ongoing challenges relating to monetary and fiscal policy, there are risks to a recovery that also remains vulnerable to unexpected shocks, domestic and foreign. Not least among these shocks, reverberations from the fast-unfolding events in Egypt, which have the potential to spread to the region’s oil exporting economies, will present a test for the recovery and for general investor sentiment – globally and in the United States – if a peaceful resolution is not forthcoming.

Rising Capacity Utilization

The advance estimate of growth, which is based on partial data and which will be revised in late February, fell just short of economists’ expectations. The headline results are welcome, nonetheless, reflecting the economy’s strongest rate of growth since Q1’10. In that quarter, GDP expanded at a rate of 3.7 percent, supported by a build up in business inventories.

Fueling concerns about the possibility of a double dip, growth had dropped off in Q2’10, to just 1.7 percent, and remained subdued in Q3’10. The newest results coincide with more tempered assessments of the downside risks to the economy. Many economists have revised up their baseline expectations for growth in 2010. From 2.9 percent for calendar year 2010, the Economist poll projects GDP growth of 3.0 percent in 2011. The consensus forecast is more optimistic, in the range of 3.2 percent.

The advance estimate of GDP growth is a positive sign for the labor market, which has failed thus far to exhibit significant momentum. As the economy grows, capacity utilization is increasing, trending back towards its long-term average. As of December, the formal measure of capacity utilization stood at 76.0 percent, significantly higher than the recession nadir of 68.2 percent but still short of the forty-year average of 80.6 percent.

Consumers Driving Growth

The Q4 results reflect an uneven improvement in overall activity. Consumers were the primary drivers of gains for the quarter, increasing spending sharply for durable goods and some services as confidence has ticked up and in spite of lackluster job growth. The improvement in consumer activity offset a decline in investment, which had otherwise been a significant contributor to growth during the previous five quarters. The residential sector was essentially flat in Q4, consistent with other measures of single-family housing and home building activity that suggest a meaningful recovery in the sector has yet to take hold.

Non-Residential Building Stable

While housing market outcomes remain a qualifier to the economic outlook, private investment in non-residential structures has improved, reporting a flat result for the quarter. During the previous nine quarters, non-residential structure investment had been declining, exerting a drag on the economy. The current result is only slightly positive and may be revised downward. Still, the advance finding reflects that new commercial property investment and development may have stabilized after a period of sharp decline.