The U.S. economy remains on track to expand at an annual rate of around 2 per cent in the first quarter of this year and by 2.5 per cent for the entire year, despite the disappointing labour market report. Household spending, while far from surging, is increasing at a steady pace. Rising gasoline prices and the sovereign debt crisis in Europe pose downside risks to the outlook; however, slowly improving labour markets will offset potential damage from these sources and the economic recovery will continue over the near term.

The economy generated a lower-than-anticipated 120,000 jobs in March and the unemployment rate fell to 8.2 per cent. Some of the details in the employment report were more encouraging and suggest that the recovery in labour markets will remain intact. The unusually warm winter shifted some hiring into January and February, and that took some steam out of the March numbers. Sectors that experienced weaker-than-expected gains included construction, health, professional services, and retail, but the increase of 37,000 positions in manufacturing was encouraging. Other measures of the overall health of U.S. labour market have been more optimistic. These include ongoing declines in weekly jobless claims and a drop in announced layoffs. We expect that economic growth over the near term will be strong enough to absorb the unemployed and, as a result, the unemployment rate will gradually decline.

Vehicle sales recorded their strongest gain in four years in the first quarter of this year. There are a number of factors boosting sales such as pent-up demand and better access to credit. The average vehicle age is currently 10.8 years and this factor, combined with improving labour markets, has led many households to replace their old cars with new ones. Credit conditions are improving, as shown by the fact that the share of loans handed out by auto finance companies to subprime borrowers has grown to 30 per cent, up from 24 per cent at the peak of the recession. Higher incentives have also helped, and there is evidence that some households are dipping into their home equity to help finance car purchases.

The economy generated a lower than anticipated 120,000 jobs in March and the unemployment rate fell to 8.2 per cent.

Interestingly, higher vehicle sales are also linked with rising gasoline prices. Consumers are trading in their gas-guzzlers for more fuel-efficient vehicles as the average price of gasoline closes in on $4 per gallon. However, if gasoline prices surge well above $4 per gallon, this substitution effect will begin to wane as households pull back on overall spending, including on new vehicles. But we do not expect gasoline prices to increase to the $5 per gallon mark—world oil prices will not surge significantly above the $100 per barrel level, as Saudi Arabia’s higher production compensates for a decline in Iranian oil exports. Also, U.S. refineries will gradually increase production as maintenance work comes to a close.

Higher gasoline prices appear to have hurt household sentiment somewhat. The Conference Board Inc.’s index of consumer confidence fell to 70.2 in March from 71.6 in February as the fear of rising gasoline prices offset the positive effect on confidence attributable to improving employment. The outlook for consumer sentiment is for gradual improvement over the near term. While consumer fundamentals are still on the mend, the economy is not about to slip back into recession, as pent-up demand remains significant and corporations are flush with cash and continue to hire.

To date, higher energy prices have not resulted in rising inflation. Core inflation is close to the Federal Reserve’s 2 per cent target and monetary authorities contend that the ongoing slack in labour markets is sufficient to keep inflation under wraps. It is for this reason that the Fed recently decided to keep short-term interest rates close to zero through 2013.