The economy unexpectedly contracted in the fourth quarter, suffering its first decline since the recession ended more than three years ago as businesses scaled back on restocking and government spending plunged.
Gross domestic product fell at a 0.1 percent annual rate after growing at a 3.1 percent clip in the third quarter, the Commerce Department said on Wednesday.
That was the worst performance since the second quarter of 2009 and showed the economy entering the new year with little momentum. Economists polled by Reuters had expected GDP to rise at a 1.1 percent rate and none had predicted a contraction.
But economists said there was no reason for panic.
Inventories and government spending sliced 2.6 percentage points from growth, a weight that was expected to lessen in the first three months of the year.
At the same time, consumer spending accelerated and business investment rebounded, suggesting some fundamental strength that should help to support the recovery even as Washington tightens its belt.
"We are not concerned that the economy is slipping back into recession," said John Ryding, chief economist at RDQ Economics in New York.
A second report showed private employers stepped up hiring in January, suggesting an improvement in the labor market. An increase in job gains could help the economy to weather the headwind of higher taxes and possible spending cuts this year.
The ADP National Employment Report showed private payrolls rose 192,000 in January after increasing 185,000 in December.
Stocks on Wall Street were mostly flat, while prices for U.S. Treasury debt fell and the dollar weakened against a basket of currencies.
The data was published as officials at the Federal Reserve wrap-up a two-day meeting. The report will likely provide ammunition for officials at the U.S. central bank to stay on their ultra-accommodative policy stance.
Economists say a growth pace in excess of 3 percent would be needed over a sustained period to significantly lower high unemployment. For the whole of 2012 the economy grew 2.2 percent, and a report on Friday is expected to show the jobless rate held at 7.8 percent for a third straight month in January.
The economy was slammed by a monster storm in late October, which caused extensive damage along the East Coast. Economists said that could have cut around 0.5 percentage point off fourth-quarter growth.
The recovery also had to deal with uncertainty over the so-called fiscal cliff of scheduled tax hikes and budget cuts, which hurt confidence even though households and businesses seemed to largely shrug off the worries.
Businesses, caught with too much inventory in their warehouses in the third quarter, slowed their stock building in the final three months of the year.
That slowdown reduced GDP growth by 1.27 percentage points, the most in two years.
But with the pick-up in consumer spending in the fourth quarter, businesses now will need to replenish stocks, which should help lift growth early this year.
"The near stall in inventories and stronger durable spending suggest greater cyclical recovery momentum than expected," said Steven Wieting, an economist at Citigroup in New York.
Excluding inventories, the economy grew at a 1.1 percent rate, slowing from the third quarter's 2.4 percent.
Government spending tumbled at a 6.6 percent rate as defense outlays plunged at a 22.2 percent pace, wiping out the previous quarter's gains. The decline in defense spending was the largest since the third quarter of 1972.
Government subtracted 1.33 percentage points from growth. The likelihood of fresh spending cuts suggests government outlays will remain a drag on the economy, but not as big of a weight as in the fourth quarter.
Export weakness also cut into GDP. Exports have been hampered by a recession in Europe, a cooling Chinese economy and storm and strike-related port disruptions. Overall trade cut a quarter of a percentage point from the change in GDP. Exports fell for the first time since the first quarter of 2009.
RISING INCOME PROVIDES A BRIGHT SPOT
In one bright spot, the report showed that income available to households after taxes and inflation increased at a strong 6.8 percent rate in the fourth quarter.
In addition, the saving rate rose by more than a percentage point, which should cushion households against higher taxes.
Consumers were helped by an easing in inflation.
A price gauge in the report advanced at just a 1.2 percent pace, down from 1.6 percent in the third quarter. So-called core prices increase just 0.9 percent, the smallest gain in two years.
Consumer spending, which accounts for more than two-thirds of economic activity, rose at a 2.2 percent rate, accelerating from the prior quarter's 1.6 percent growth pace, while business investment rebounded after its first drop in 1-1/2 years.
The housing market was another positive.
Residential construction grew at a 15.3 percent rate after notching a 13.5 percent growth pace in the third quarter.
Homebuilding added to growth last year for the first time since 2005.
"A turnaround in the housing market will be a key support to the economy this year, with homebuilding contributing to growth and higher home prices supporting consumer spending," said Stuart Hoffman, chief economist at PNC Financial in Pittsburgh.
(Additional reporting by Leah Schnurr in New York; Editing by Andrea Ricci)