Fears of Slowdown Fade as Economy Shows Some Muscle

(Reuters) -- A few months ago economists were all but certain the U.S. economy would slow sharply at the start of this year, with many warning that recession risks were growing.

That pessimism has been shaken off by a string of surprisingly solid data that paint a picture of an economy with building momentum.

The jobs market is picking up, manufacturing is accelerating and the service sector is also flexing its muscle - good news for President Barack Obama, who faces an election battle in November.

We were among those people that had been expecting growth to slow. It now seems a lot less likely, said Jeremy Lawson, an economist at BNP Paribas in New York.

The main reason for this newfound optimism is rising employment, which should help support the consumer spending that drives two-thirds of U.S. economic activity.

Even Nobel economist Paul Krugman, who has pushed for years for more aggressive policies to spur growth, let a notable ray of light into his latest New York Times column, coupled as it was with a reminder that the economy remained depressed.

It's not hard to see how this recovery could become self-sustaining, he wrote.

Employers added 243,000 new jobs in January, the most in nine months, and the jobless rate dropped to a three-year low of 8.3 percent.

In manufacturing, activity picked up for a third straight month in January with a growing backlog of orders suggesting the strength would be maintained.

A similar picture emerged from the economy's vast services sector, which enjoyed its strongest month in nearly a year.

The downside risks are evaporating and we are seeing some upside risks to growth, said Harm Bandholz, chief U.S. economist at Unicredit Research in New York.

RECESSION FEARS FADE

Last summer, an already weak economy took a blow from Europe's sovereign debt crisis and an ugly fight in Washington over budget policy that cost the nation its AAA credit rating.

Business and consumer confidence plummeted, stock markets sank and economists began to warn of recession.

The loss of confidence, however, threw economists off track. The recovery actually accelerated into the end of the year, and by December it was increasingly clear some of that momentum would last.

Late last summer, I saw a 50-50 chance of recession. I have dialed that down quite a bit, said Robert Dye, chief economist at Comerica in Dallas. He now sees recession odds below 25 percent.

While households dipped into their savings late last year as they stepped up spending, with job growth accelerating it increasingly appears that rising income will begin to bear the load.

Personal income jumped by the most in nine months in December and January's employment gains suggest another decent increase last month.

The data has led Wall Street firms to push their GDP forecasts higher.

BNP this week more than doubled its first quarter growth forecast to a 2.5 percent annual rate, barely a slowdown from the fourth quarter's 2.8 percent clip.

Deutsche Bank is now penciling in 2.8 percent growth, up from 2 percent; Morgan Stanley lifted its forecast to 2.2 percent from 2.0 percent; and economists at TD Securities see output rising at a 2 percent rate instead of 1.6 percent.

Goldman Sachs said it might rethink its 2-percent growth forecast for 2012 if upside surprises keep rolling in.

It wasn't supposed to be like this.

Two-thirds of the fourth-quarter's growth was driven by a rebuilding of business inventories, much of it concentrated in autos. As that effort slowed, the economy was supposed to cool as well.

But auto sales rose in January at their fastest pace in nearly 2-1/2 years, making inventories look far from bloated.

While mild winter weather helped spur economic activity over the last two months, economists are increasingly convinced that jobs and income are starting to drive the recovery.

There are hints that a virtuous cycle may be building where employment, income and consumer spending move up together, said Nigel Gault, chief U.S. economist at IHS Global Insight.

(Reporting by Lucia Mutikani; Editing by Padraic Cassidy)