By Lucia Mutikani

WASHINGTON (Reuters] – The U.S. experienced a sharp slowdown in economic growth during the first quarter. A wave of COVID-19 case settlements slowed activity but left enough strength to sustain expansion despite headwinds from rising interest rates and soaring inflation.

A surge in imports would cause the growth rate to slow down, as it is expected that the pace of the recovery will be slower than the one caused by the pandemic nearly two years back. The question of whether inventory growth would be reflected in gross domestic products growth is a matter for debate among economists. After they were responsible for much of the acceleration in GDP during the fourth quarter, inventories are also questioned.

While the Commerce Department released its first-quarter GDP report Thursday morning, it could be seen as warnings about stagflation or recession. Economists warn that even though a low number of growth would seem to reflect the truth of the economy’s performance, other output indicators such aggregate hours worked, industrial production, and manufacturing showed continued growth.

James Knightley from ING, New York said that “we do need to keep in mind the context for why it’s slowing.” The Omicron Wave, which hit confidence as well as people’s movement, partially explains this. Now that it’s over in a decent state, we can look forward for better growth for the next quarter.

A Reuters survey showed that GDP growth was likely to have increased by 1.1% annually last quarter, according to economists. This would represent a significant drop from the 6.9% annualized rate recorded in the fourth quarter. There were estimates ranging from a 1.4% growth rate to an extremely low contraction rate.

Federal Reserve will likely raise interest rates by 50 base points on Wednesday and then begin trimming asset holdings. In its battle against inflation, the U.S. central banking raised its policy rate 25 basis points in March. This was its first increase in over three years. The March increase in annual consumer prices was the fastest in over 40 years.

However, the GDP survey was done before Wednesday’s release of data that showed a record-breaking goods trade deficit for March as well as continued growth in wholesale and retail inventories.

Goldman Sachs’ (NYSE:) first quarter GDP estimate was lowered to 1.3% from 1.5% due to the increase in goods trade deficit. Citigroup (NYSE: ) Predicted that the economy would contract at a rate of 1.2%.

According to economists, the surge in imports, which was attributed by them to business front-loading fearful of shortages caused by Russia-Ukraine war will hurt growth. However, it is also an indicator of strong domestic demand and should therefore be the primary focus of the GDP report.

According to some estimates, the wider trade deficit may have slowed GDP growth by as much as 1.5 percent last quarter. Imports fill the gap because local producers lack the ability to satisfy the demand. This would mark the seventh consecutive quarter in which trade has been subtracted from GDP growth.

Strong Domestic Demand

The fourth quarter saw a 2.5% increase in consumer spending. However, this pace was affected by Omicron virus, the Omicron variant of the coronavirus. There is still no indication that consumers are slowing down, despite the fact that food and gasoline prices have risen.

Inflation is being protected by strong wage growth and a tighter labor market. There are also approximately $2 trillion of excess savings that were accumulated in the aftermath of the pandemic. Bank of America (NYSE Securities) data shows that consumers with lower incomes, which are more likely to be affected by inflation, showed greater resilience.

Anna Zhou from Bank of America Securities in New York, stated “The consumer with a lower income will likely continue to be resilient at minimum until the end of next year.”

But the future is uncertain for next year. The price of gasoline will continue to rise for theforeseeable future and they will eventually impact consumer purchasing power even with strong balance sheets.

In addition to solid growth in equipment purchases, businesses are also expecting strong growth. A measure of domestic demand, which excludes trade, inventories, and government spending, is expected to grow at almost twice the pace of 2.6% in fourth quarter. About 85% of total spending comes from final sales to domestic private purchasers.

Kevin Cummins, chief U.S. economist for NatWest Markets Stamford (NYSE:), stated that “this is consistent with solid underlying momentum within the economy despite any pullback by Omicron or the further rise in prices due to war in Ukraine.”

However, there are concerns that the Fed might tighten its monetary policy aggressively and plunge the economy into recession in the coming 18 months. With the 30-year fixed mortgage rate at a record 5%, signs are already beginning to show that the housing market is slowing.

Much would hinge on the speed at which geopolitical tensions, supply chains and inflation improve.

Sam Bullard, senior economist at the University of Texas, stated that solid fundamentals and still-accommodative economic conditions could help to support an extension of the recovery. Wells Fargo Charlotte (NYSE) There are two main risks to consider: global economic weakness and tighter finances. These should both be taken seriously and monitored.