Robust consumer spending, AI-related investment power US economy in third quarter

By Lucia Mutikani

WASHINGTON, Oct 29 (Reuters) – The US economy grew at its fastest pace in a year in the third quarter, shrugging off higher oil prices stemming from the conflict in the Middle East as consumers maintained robust spending and businesses doubled down on investment in AI.

The better-than-expected increase in gross domestic product last quarter reported by the Commerce Department on Thursday was in stark contrast to households’ downbeat assessment of the economy, reflected in President Donald Trump’s record-low approval ratings and deterioration in consumer sentiment.

The advance GDP report was published less than a week before Tuesday’s midterm elections, which will determine control of Congress. Economists said the strong growth, together with other data on Thursday showing inflation accelerating and broadening out in September, bolstered the argument for the Federal Reserve to raise interest rates in December.

The US central bank on Wednesday left its benchmark overnight interest rate in the 3.75%-4.00% range while acknowledging that inflation “remains elevated.”

“The consequences of an economy at full employment in addition to a historic capital expenditures expansion are on vivid display,” said Joseph Brusuelas, chief economist at RSM. “If the Fed is looking for more information on why they should act to restore price stability they can find it inside a slate of robust spending … stratospheric private non-residential investment and sizzling inflation data.”

Gross domestic product increased at a 3.4% annualized rate last quarter, the quickest since the third quarter of 2025, the Commerce Department’s Bureau of Economic Analysis said in its first estimate of third-quarter GDP. Economists polled by Reuters had forecast GDP advancing at a 3.2% pace.

The economy is expanding at a pace that is well above what some Fed officials regard as the non-inflationary growth rate of around 2%. Stocks on Wall Street were trading lower. The dollar slipped against a basket of currencies. US Treasury yields fell.

Consumer spending, which accounts for more than two-thirds of the economy, increased at a 3.8% rate in the July-September period, matching the second quarter’s pace. It was largely driven by services, including healthcare, visits to restaurants and bars as well as hotel and motel stays.

There was a pullback in spending on goods like motor vehicles and household furniture. Higher-income households, whose wealth has been boosted by AI-related strength in the stock market, are driving much of the spending.

Historically low layoffs and moderate hiring are also helping other households to sustain spending, though wage gains have at times lagged inflation. Households are also saving less and dipping into their nest eggs. The saving rate fell to 4.1% from 4.4% in the second quarter. It fell to 3.8% in September.

“Growth isn’t enough to give American families economic security,” said Kyle Moore, chief economist at the Century Foundation. “Most of that growth has been lopsided, focused on the AI buildout. Wages for the typical worker still aren’t keeping up with increasing prices.”

Business spending on equipment surged at a 20.9% rate, the fastest since the third quarter of 2020. That added 1.16 percentage points to GDP growth, the most in six years. Information processing equipment, mainly computers and peripheral equipment, made up the bulk of the contribution.

Business spending on intellectual property products grew at an 8.4% rate, adding just under half a percentage point to GDP growth, mostly coming from software and research and development. Robust consumer and business spending were both sated with imports, which are a drag in the calculation of GDP.

Imports increased at a 19.7% rate, the quickest since the first quarter of 2025, when businesses were front-loading orders to avoid higher costs from Trump’s sweeping tariffs.

LARGE DRAG FROM IMPORTS

Imports last quarter sliced off 2.64 percentage points from GDP growth, which was more than offset by the strength in consumer and business spending as well as a 1.61 percentage point contribution from the rebuilding of inventories, which had been drawn down for five straight quarters.

Government spending increased at a 5.3% rate amid a sharp rebound in federal government outlays, both defense and nondefense. Rising mortgage rates because of the Middle East conflict pushed residential investment back into contraction last quarter. Higher borrowing costs have overshadowed a moderation in house prices, weighing on demand for housing.

A measure of domestic demand, which excludes inventories, trade and government, accelerated at a 4.9% rate, the strongest since the second quarter of 2021. Final sales to private domestic purchasers grew at a 4.6% rate in the second quarter. Economists viewed the current pace of demand as unsustainable.

While inflation subsided last quarter as the cost of energy eased, price pressures picked up at the end of the third quarter.

The Personal Consumption Expenditures price index increased 0.5% in September after rising 0.3% in August, the BEA said in a separate report. In the 12 months through September, PCE inflation advanced 3.6% after rising 3.4% in August. It is one of the measures tracked by the Fed for its 2% inflation target. Rising inflation, with average gasoline prices still above $4 a gallon as the US-Israeli war with Iran drags on, left economists anticipating a slowdown in economic growth by year end.

Income at the disposal of households after accounting for inflation and taxes dropped 0.3% last month after being flat in August. Inflation-adjusted consumer spending was unchanged in September after rising 0.5% in August, putting consumption on a weaker growth path heading into the fourth quarter.

Economists also expected some moderation on AI-related spending as investors are focusing on the rising costs of long-term projects in which the payoff is uncertain. Tech firms have borrowed huge sums over ​the past year for AI spending, a potential downside risk to equipment spending.

“An economy increasingly supported by stock-market wealth and large technology projects also faces risks if share prices retreat or investment plans disappoint,” said Sung Won Sohn, a finance and economics professor at Loyola Marymount University.

(Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci)