AI Boom, Government Spending Rebound Lifted US Economy in 1Q

U.S. economic growth regained speed in the first quarter as businesses boosted investment in artificial intelligence and government spending rebounded after a crippling shutdown, but the pickup is likely temporary, with the Middle East conflict raising inflation and eroding household purchasing power.

The Commerce Department’s advance estimate of gross domestic product on Thursday showed consumer spending, the economy’s main engine, losing further momentum last quarter even before the U.S.-Israeli war with Iran raised the average U.S. gasoline price to above $4 a gallon.

The pain at the pump was another blow for households, already burdened by high prices stemming from President Donald Trump’s tariffs, economists said.

Inflation accelerated at its fastest pace in nearly three years in March, deepening frustration among Americans over the rising cost of living. Most Americans disapprove of Trump’s stewardship of the economy, a political risk for the Republican Party heading into congressional midterm elections in November.

“The economy still has momentum, but the road ahead is more dangerous than the GDP number suggests,” said Sung Won Sohn, a finance and economics professor at Loyola Marymount University. “With inflation above comfort levels, consumers under pressure and tariff policy distorting trade and business decisions, the economy is entering a more fragile phase.”

Gross domestic product increased at a 2.0% annualized rate last quarter, the Commerce Department’s Bureau of Economic Analysis said. Economists polled by Reuters had forecast GDP growth increasing at a 2.3% annualized rate. Estimates ranged from a 0.2% pace of contraction to a 3.9% growth rate.

The economy grew at a 0.5% pace in the fourth quarter. Economists expect the war in the Middle East to weigh on economic growth from the second quarter.

The AI spending boom and the building of data centers underpinning the technology helped to lift business spending on equipment, which increased at a 17.2% rate after rising at a 4.3% pace in the fourth quarter. Spending on intellectual products increased at a 13% rate. They more than offset the ninth straight quarterly decline in investment in nonresidential structures like factories, the longest such stretch on record.

Overall business investment added more than a full point to GDP growth. Government spending rebounded at a 4.4% pace, with federal outlays increasing at a 9.3% rate. Some of the output lost during last year’s 43-day shutdown will never be recovered.

Though business inventories were drawn down for a fourth consecutive quarter, they still added 0.4 percentage points to output. The AI spending spree pulled in more imports, leading to a widening in the trade deficit that subtracted 1.30 percentage points from GDP growth. Residential investment contracted for a fifth straight quarter as high mortgage rates continued to stifle the housing market.

Still, the strength in business investment helped to mitigate the slowdown in consumer spending, which increased at a 1.6% rate after advancing at a 1.9% pace in the fourth quarter. Growth in consumer spending, which accounts for more than two-thirds of the economy, has decelerated from a 3.5% rate in the third quarter of 2025.

Stocks on Wall Street were trading higher. The dollar fell against a basket of currencies. U.S. Treasury yields were lower.

Low Layoffs Anchoring Labor Market

Consumer spending is being restrained by slowing growth in household incomes and an erosion of purchasing power by high inflation. The personal consumption expenditures price index increased at a 4.5% pace last quarter, the fastest since the third quarter of 2022.

PCE inflation jumped 3.5% year-on-year in March, the biggest rise since May 2023, a separate report from the BEA showed.

The PCE price index is one of the inflation measures tracked by the Federal Reserve for its 2% target. Income at the disposal of households after accounting for inflation fell again in March.

Higher inflation could offset some of the anticipated stimulus from tax cuts, economists warned. The boost from larger tax refunds was expected to fade soon, leading to what they said would be weaker spending this year.

Though layoffs have remained low, with a third report from the Labor Department showing first-time applications for unemployment benefits last week dropping to the lowest level since May 1969, employers have been hesitant to increase hiring because of lingering uncertainty from tariffs.

Businesses face more uncertainty from the Middle East conflict, which is raising the prices of oil, fertilizers and other commodities that are shipped through the Strait of Hormuz.

The labor market has slowed significantly compared to 2023 and 2024, with economists also pointing to the Trump administration’s immigration policy, which they said had reduced the supply of workers. That has curbed wage growth.

Wages and salaries, adjusted for inflation, rose 0.1% in the 12 months through March, after increasing 0.7% year-on-year in December, a fourth report from the Labor Department showed.

Consumers have relied on savings or have been saving less to maintain their spending. The saving rate dropped to 3.6% in March, the lowest level since October 2022, the BEA reported.

Despite the moderation in consumer spending, the pace was sufficient to help underpin the economy. A measure of domestic demand that excludes government spending, inventories and trade, increased at a solid 2.5% pace after rising at a 1.8% rate in the October-December quarter.

That, combined with labor market stability and rising inflation, supported financial market expectations that the U.S. central bank will hold interest rates steady, possibly into 2027. The Fed on Wednesday left its benchmark overnight interest rate in the 3.50%-3.75% range, noting growing inflation worries.

“The broader challenge is that the U.S. economy is confronting the price of growth,” said Lydia Boussour, senior economist at EY-Parthenon. “A sequence of supply shocks – from trade policy and tariffs to demographics and immigration, and now the Middle East conflict – continues to put upward pressure on inflation while weighing on growth.”