WASHINGTON (MarketWatch) - The U.S. economy barely grew in the fourth quarter, pulled down by a worsening slump in housing and heightened caution by consumers and businesses, the Commerce Department reported Wednesday.

The 0.6% annualized growth rate in gross domestic product was lower than the 1.1% expected by economists surveyed by MarketWatch. The drag from inventories was larger than expected. See Economic Calendar.

"The GDP hit stall speed," wrote Joseph Brusuelas, chief U.S. economist at IDEAglobal.

GDP hadn't been any slower since the end of 2002, when the economy was struggling to recover from the recession a year earlier.

Consumer spending and business investments slowed slightly in the fourth quarter, while investments in houses fell at the fastest rate in 26 years. Businesses reduced their inventories. Exports grew at a slower pace as well. Read the full government report.

The economy grew at a 4.9% pace in the third quarter.

For all of 2007, GDP grew 2.2%, the slowest growth since 2002. GDP increased at a 2.9% rate in 2006.

Economists expect tepid growth to persist through the first half of the year.

The Fed

"Even if fourth-quarter GDP growth was not negative, it was weak, and prospects for the first quarter are not materially better," said Ken Mayland, chief economist for ClearView Economics. "It may not be 'recession,' but growth at this level is not acceptable. The Fed needs to buy some insurance."

The GDP report comes just hours before the Federal Reserve will announce its latest decision about whether to lower interest rates.

Last week, the Fed slashed its target rate by three-quarters of a percentage point in an emergency move after financial markets sold off around the world. Markets and economists expect the Federal Open Market Committee to cut overnight rates by another half a point at the end of Wednesday's meeting. See full story.

Even as growth slowed, core inflation heated up, the government said. The core personal consumption price index rose at a 2.7% annual rate in the quarter, far above the Fed's goal of 1% to 2% and the fastest pace of inflation seen in six quarters.

In the past year, core inflation, which excludes volatile food and energy prices, has increased 2.1%.

Prices of all consumer goods and services rose 3.4% in the past year.

The combination of weaker growth and accelerating inflation puts Fed policymakers in a quandary: Cut interest rates to boost growth, or hike rates to stop inflation.

But the Fed's signaled that it believes the risks to growth far outweigh the risks of higher inflation, and has been cutting interest rates aggressively to get growth back on track.

In a separate report Wednesday, payroll-processing giant ADP's employment index rose 130,000 in January, suggesting growth in nonfarm payrolls could be much stronger than the 70,000 now anticipated by economists. See full story.

Details

Wednesday's report was the first of three estimates of fourth-quarter GDP. The government will revise the figures in a month with more up-to-date data, including figures on inventories, construction spending and trade for December.

GDP for 2007 was $13.84 trillion, not adjusted for inflation.

Real disposable incomes increased 0.3% in the final three months of 2007. The personal savings rate was 0.2% of personal income, the lowest in five quarters.

Final sales of domestic product, which includes foreign and domestic sales of all goods and services produced in the United States, increased 1.9%. Domestic sales increased 1.4%.

In the fourth quarter, consumer spending increased 2% annualized, downshifting from 2.8% growth in the third quarter. Spending on durable goods rose 4.2%, spending on nondurable goods rose 1.9% and spending on services grew 1.6%.

Consumer spending added 1.4 percentage points to growth.

Business investments increased 7.5% in the fourth quarter after having risen by 9.3% in the third. Investments in equipment and software rose 3.8%, while investments in structures increased 15.8%. Business investment contributed 0.8 of a percentage point to growth.

Inventories fell by $3.4 billion in the October-through-December quarter -- a positive sign for future growth because lean inventories now will spur additional production once demand rebounds. The change in inventories subtracted 1.3 percentage points from growth.

Residential investments plunged 23.9% annualized in the fourth quarter, a steeper drop after falling 20.5% in the third quarter, the biggest drop since 1981. Residential investments have fallen for eight straight quarters.

Housing subtracted 1.2 percentage points from fourth-quarter growth, the government said. For all of 2007, investments in homes fell 16.9%, marking the largest decline since 1982.

Exports increased 3.9% in the fourth quarter, an improvement over the 19.1% seen in the third quarter. Imports rose 0.3% after a 4.4% gain in the third. Net exports contributed 0.4 of a percentage point to growth.

Government spending increased 2.6%, after rising 3.8%. Federal spending increased 0.3%, while state and local government spending rose 4%, the biggest gain in six years. Government spending contributed 0.5 of a percentage point to growth.