WASHINGTON--The U.S. economy grew at its fastest pace in two years in the third quarter, fueled by robust consumer spending and a sharp rebound in exports, though momentum appears to have faded amid the rising cost of living and recent government shutdown.
The stronger-than-expected increase in gross domestic product last quarter, which was reported by the Commerce Department on Tuesday, also reflected continued investment by businesses in equipment and artificial intelligence. Government spending, mostly on defense, also provided a lift.
Only inventories and residential spending, which includes homebuilding and sales, acted as drags on GDP. The increase in consumer spending was the fastest in nearly a year as households splurged on recreational goods and vehicles and travelled internationally.
Though the economy fired on all cylinders last quarter, economists said activity had assumed what they termed a K-shape pattern, with higher-income households and big corporations doing the heavy lifting.
Economists blamed this phenomenon on President Donald Trump's policies, including aggressive import tariffs, which have raised prices. A stock market boom and still-high home prices have cushioned upper-income households against inflation while lower- and middle-income households face a limited ability to substitute purchases, economists said.
Similarly, large companies have sufficient resources to offset the rising costs from import duties, they added. In contrast, small businesses are barely staying above water, and are also struggling with a reduction in low-cost labour supply amid an immigration crackdown, economists said.
"The K-shaped economy is staring us right in the face," said James Knightley, chief international economist at ING. "Neither of these trends, high-income household spending and tech capex (capital expenditure), appear to be weakening and in all likelihood they are going to continue to propel growth in 2026."
Gross domestic product increased at a 4.3% annualized rate last quarter, the fastest pace since the third quarter of 2023, the Commerce Department's Bureau of Economic Analysis said in its initial estimate of third-quarter GDP. Economists polled by Reuters had forecast GDP would rise at a 3.3% pace. The economy grew at a 3.8% pace in the second quarter.
But when measured from the income side, the economy grew at a moderate 2.4% rate, slowing from the 2.6% pace logged in the April-June quarter. Domestic demand increased at a 3.0% pace, little changed from the prior quarter. Nonetheless, the report, which was delayed by two months because of the shutdown, widened the gap between GDP growth and the sluggish labor market.
That change suggested worker productivity was strong. Economists said the bullish performance last quarter and elevated inflation argued against the Federal Reserve cutting interest rates again in January and beyond."Given the economy's resilience, softness in both employment and inflation might be needed to spur rate cuts in 2026," said Sal Guatieri, a senior economist at BMO Capital Markets.
Consumer spending increased at a 3.5% rate in the third quarter, the strongest pace since the fourth quarter of 2024, after advancing at a 2.5% pace in the April-June period.
In addition to recreational goods and vehicles, consumption was also boosted by spending on non-durable goods like food for consumption at home, prescription medication, apparel and footwear. Consumers also spent more on healthcare, including outpatient, hospital and nursing home services.
But a pullback is expected. Retail sales stalled in October, while motor vehicle purchases have dropped in the past two months. Consumer confidence is deteriorating, while growth in inflation-adjusted income at the disposal of households has stagnated and the saving rate fell in the third quarter to near levels last seen in late 2022.
The non-partisan Congressional Budget Office has estimated the recent government shutdown could slice between 1.0 percentage point and 2.0 percentage points off GDP in the fourth quarter. It projected most of that drop would be recovered, but estimated between $7 billion and $14 billion would not.
