Housing Slump Slows Economy

The cooling housing market sent a chill through the economy in the third quarter, helping to slow growth to its weakest pace in more than three years, the government said yesterday.

The nation's gross domestic product, the value of all goods and services produced, expanded at a sluggish 1.6 percent annual rate in the quarter, down from a moderate 2.6 percent pace in the second quarter, the Commerce Department reported. In the first three months of the year, the economy grew at a sizzling 5.6 percent annual rate.

With less than two weeks to go before the midterm congressional elections, the report instantly became campaign ammunition. Democrats emphasized the slowdown while Republicans highlighted signs of economic strength.

Financial analysts were split on whether the report reflected an economy poised for a rebound or headed into a prolonged slump. The debate turns on differing forecasts of how the housing market will affect consumer spending.

The sharp slowdown during the year resulted from a combination of soaring energy prices, rising interest rates and plunging home construction and sales. Oil prices and the cost of a 30-year fixed-rate mortgage peaked in July, and gasoline averaged around $3 a gallon for much of the summer.

Home building plunged at a 17.4 percent annual rate in the third quarter, the steepest fall in four consecutive quarters of declines, the report showed.

"A downturn in the housing market packed a wicked punch for the U.S. economy in the third quarter, but it was not a knockout blow," said Stuart G. Hoffman, chief economist of PNC Financial Services Group.

Optimists note that some forces behind the slowdown have eased. The Federal Reserve has held short-term interest rates steady since June, and mortgage rates have fallen since July. Gaso line and other fuel prices have tumbled since mid-August, putting more cash into consumers' pockets to spend on other things.

Both consumer spending and business investment outside of housing rose faster in the third quarter than in the second, and unemployment remains low, encouraging many analysts to predict that the economy will regain momentum in the coming months.

"The recent slowdown will prove temporary," said James W. Paulsen, chief investment strategist at Wells Capital Management. "Outside of the housing and auto industries, economic growth remains strong and has actually been accelerating."

Other observers were more pessimistic, expecting the housing slump to deepen and continue into next year. That would push up unemployment and prompt consumers to rein in spending, holding economic growth to a crawl through 2007, they said.

"The correction in the housing sector still has a long way to go and the full impact on consumption won't become apparent until next year," said Paul Ashworth, senior U.S. economist for Capital Economics Ltd.

The divergent forecasts explain why the Federal Reserve left its benchmark short-term rate unchanged Wednesday. Central bank policymakers generally share the more upbeat outlook but see the possibility that the economy could weaken more than they expect.

The Commerce Department report also supported the Fed's forecast that slowing economic growth will gradually weaken inflation. Consumer prices, excluding food and energy prices, rose at a 2.3 percent annual rate in the third quarter, according to a Commerce Department price index. That's higher than many central bank policymakers prefer but lower than the 2.7 percent pace of the second quarter.

Heading into the final campaign stretch, President Bush and other Republicans have emphasized the good economic news, such as the low 4.6 percent unemployment rate, rising incomes and falling oil prices.

"It is a healthy economy," Treasury Secretary Henry M. Paulson said yesterday during an interview on CNBC. "The economy is creating new jobs . . . there has a been a real increase in wages."

Democrats countered that the Commerce Department figures reflect a weakening economy.

"Once again, the Bush economy is going in the wrong direction," said Rep. Carolyn B. Maloney (N.Y), the senior House Democrat on Congress's Joint Economic Committee. "An economic recovery that never benefited working Americans in the first place now has slowed to a crawl. President Bush's economic happy talk is betrayed by the facts on the ground and the stats released today."