Economic activity slumped more than expected in the fourth quarter, with the revised GDP growth rate now showing an annualized decline of 6.2% compared to the advance estimate of -3.8%, the largest quarterly decline since the first quarter of 1982 when the U.S. economy was in the throes of the 1981-82 recession. Market expectations had been for a downward revision to -5.4% in the face of a number of weaker-than-expected economic reports that have been released during the past month.

The downward revision reflected greater weakness in a number of components. The most significant was inventories that were revised down by US$26.1 billion and, thus, accounted for about one-third of the overall downward revision to GDP. This partially corrected the unexpected upward surprise in the advance GDP report showing much less weakness in inventories, and hence overall GDP growth, than had been anticipated.

Today’s report also showed a significant downward revision to both export growth to -23.6% from -19.7% and consumer spending to -4.3% from -3.5%. The only minor offset came from residential investment. This component still showed a sizeable decline in the quarter of 22.2% compared to the previous estimate of -23.6%.

Annualized quarterly growth in the core PCE deflator, the key inflation measure in the GDP report, was unexpectedly revised up to 0.8% from the advance estimate of 0.6%. This price measure rose 2.4% in the third quarter.

The revised decline in the fourth quarter indicates that activity weakened markedly at the end of last year. This weakness is consistent with a rapid deterioration in labour markets through the quarter. Indications that employment continues to fall sharply going into 2009 augur poorly for any imminent turnaround in declining economic activity in the first quarter. This is the case despite today’s report indicating less of an inventory overhang going into 2009.

Continued weak growth makes clear the need to keep policy accommodative to counter the growing macroeconomic fallout from the credit tightening. The Obama Administration has moved aggressively on fiscal policy, getting a US$787-billion stimulus package through Congress. With Fed funds already abutting 0%, the central bank continues to directly inject liquidity where required into the financial system in order to get various market interest rates lower.

In addition, the Administration is directly addressing the credit tightening by taking increasingly large equity positions in various financial institutions, such as the Citigroup announcement this morning. Such actions are attempts to convince financial markets that the toxic effect of the sub-prime mortgages and related assets will be contained.

RBC Financial Group

The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.