Inventories added 3.8 percentage points to fourth-quarter growth and 1.6 percentage points to first-quarter growth. Inventories actually rose for the first time in two years (rather than just falling more slowly, as they did in the fourth quarter). The biggest increase was in retail motor vehicles and parts. Although faster inventory accumulation in the first quarter may mean that there's less extra boost to growth from inventories in the future, the inventory accumulation that we are now seeing is healthy. Inventories are not rising because sales are coming in low, but because producers are more confident about the future and are seeking to rebuild stocks that were run down in the recession.

Final sales growth eased slightly, from 1.7% to 1.6%, and was softer than we expected, although this may be linked to the upside inventory surprise. Imports (which are a drag on final sales) rose more than expected, suggesting that some of the inventory surprise was due to increased imports. Final sales to domestic purchasers, which net out foreign trade, rose 2.2%, up from 1.4% growth in the fourth quarter.

Domestic spending was led by consumers, whose spending rose 3.6%—the biggest increase in three years, and in contrast with the lackluster first-quarter consumer confidence numbers. Since real disposable income was flat, the rise in spending was entirely driven by a lower saving rate (the saving rate fell to 3.1%, from 3.9% in the fourth quarter). This underlines that rising employment is crucial to provide income support for spending over the rest of the year—although it seems that employment is indeed now beginning to turn.

Apart from the consumer spending improvement, the best news in the report was of a very solid 13.4% increase in business spending on equipment and software. This was not as fast as the 19.0% increase in the fourth quarter, but we had expected a sharper deceleration still. As in the fourth quarter, the improvement was led by high-tech spending, with information-processing equipment and software up 15.6%. Evidence of strong incoming orders in the ISM surveys and the durable goods reports (excluding aircraft) suggest another strong gain in business equipment spending during the second quarter.

There were still several weak areas, though. Construction in all sectors—nonresidential (down 14.0%), residential (down 10.9%), and state and local (down 18.6%)—showed steep declines, exacerbated by bad weather, with only surging energy drilling preventing an even bigger decline for nonresidential structures. Residential construction should gradually improve from here on, but nonresidential construction has further to fall. The decline in state and local construction spending partly reflects budget woes. Federal stimulus support has relieved those problems a little, but only temporarily, and with budget cuts now biting more severely, overall state and local spending fell 3.8% in the first quarter—the largest such cut for almost 30 years.

With imports rising 8.9% while exports rose just 5.8% (both up much more slowly than in the fourth quarter), net foreign trade was a drag on GDP growth to the tune of 0.6 percentage point. We expect exports to do much better in coming months, because recent survey evidence suggests that export orders for both manufacturing and services have been rising rapidly.

The inflation evidence was benign. The core personal consumption price index rose just 0.6% at an annualized rate over the fourth quarter, and 1.4% over the past year. This reflects the absence of any upward pressure on the core CPI in recent months, and will reinforce the Federal Reserve's view that it is too early to be thinking of tightening monetary policy.

Although headline growth was slower in the first quarter than the fourth, the evidence suggests that the recovery is broadening and becoming more firmly established, especially now that the consumer has stepped up. The message from most high-frequency indicators is that the economy gained momentum as the first quarter progressed, and regional manufacturing surveys for April have been very strong, so the second quarter should see stronger growth than the first (4% plus).

Although double-dip risks are rapidly receding, there are many reasons to expect growth to cool in the second half of the year (notably fading stimulus effects and a diminishing inventory boost). The extent of the softening will depend on employment, because the consumer needs income support. We will finalize our next monthly forecast on May 10. We anticipate that 2010 growth will come in closer to 3.5% than to our April forecast of 3.0%.