Consumer spending rose 0.7 per cent in February from January, the Commerce Department said Friday. It was the biggest gain in five months and followed a revised 0.4 per cent rise in January, which was double the initial estimate.
Americans were able to spend more because their income rose 1.1 per cent last month. That followed huge swings in the previous two months, which reflected a rush to pay bonuses and dividends in December before taxes increased.
After-tax income also increased 1.1 per cent last month, allowing consumers to put a little more away. The saving rate increased to 2.6 per cent of after-tax income, up from 2.2 per cent in January.
The gains in spending and income follow other signs of an economy gathering momentum. Hiring is up, businesses are spending more, the stock market is hitting record levels and the housing recovery is strengthening.
More spending by consumers should boost economic growth in the January-March quarter after a lull at the end of last year. Consumer spending accounts for 70 per cent of economic activity.
After seeing Friday's report on consumer spending, Paul Ashworth, chief U.S. economist at Capital Economics, raised his growth forecast for the first quarter by a full percentage point. Ashworth now expects growth in the January-march quarter increase to an annual rate of 3 per cent.
Growth at that pace would be a vast improvement from the 0.4 per cent rate in the October-December quarter, which was held back by slower company stockpiling and the sharpest defence cuts in 40 years.
Ashworth called the boost in spending "impressive," noting that consumers spent more while having to adjust to the higher Social Security taxes and a spike in gasoline prices.
"We're now likely to see the fastest quarterly gain in real consumption in two years," he said.
Jennifer Lee, senior economist at BMO Capital Markets, said the increases suggest consumer spending could be growing in the first quarter at an annual rate of more than 3 per cent. That would be the fastest gain in more than three years and more than double the 1.3 per cent rate in the fourth quarter.
Inflation, as measured by a gauge tied to consumer spending, increased 1.3 per cent in February compared with a year ago. That's well below the Federal Reserve's 2 per cent target, giving the central bank room to keep stimulating the economy without having to worry about price pressures.
Consumers spent more at the start of the year even after paying higher taxes. An increase in Social Security taxes has reduced take-home pay for nearly all Americans receiving a paycheque. And income taxes have risen on the highest earners. The tax increases both took effect on Jan. 1.
One reason the tax increases haven't slowed the economy is companies have accelerated hiring and are slowly but steadily increasing wages.
Employers have added an average of 200,000 jobs a month since November. That helped lowered the unemployment rate in February to a four-year low of 7.7 per cent. Economists expect similar strong job gains in March.
Businesses are also investing more in equipment and machinery, which has given factories a lift after a disappointing 2012.
And the housing recovery that began last year appears to be sustainable. In February, sales of previously occupied homes rose to the highest level in more than three years. The gains have helped lift home prices, which have made Americans feel wealthier.
Stock prices have also surged. On Thursday, the Standard & Poor's 500 index closed at a record high of 1,569. That surpassed the previous record of 1,565 set in October 2007, a year before the peak of the financial crisis.
Three weeks ago, the Dow Jones industrial average beat its 2007 record.
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