US GDP Growth Slows to 1.4% in Q4, PCE Inflation Accelerates
Stagflation concerns mount as economy decelerates sharply and Fed's preferred inflation measure unexpectedly rises
US economic growth sharply decelerated in the fourth quarter of 2025, expanding at an annualized rate of 1.4% and falling well short of economists' expectations for 3% growth, according to advance estimates from the Bureau of Economic Analysis. The marked slowdown follows a robust 4.4% expansion in the third quarter, signaling a significant loss of momentum as the year concluded.
Adding to policymakers' challenges, the Personal Consumption Expenditures price index—the Federal Reserve's preferred inflation gauge—accelerated to 2.9% year-over-year in December from 2.8% in November. The core PCE measure, excluding volatile food and energy costs, rose to 3% from 2.8%, surpassing forecasts that anticipated a more modest increase to 2.9%.
The combination of slowing growth and rising inflation raises the specter of stagflation, presenting a complex dilemma for Federal Reserve officials already wrestling with the appropriate policy response. The divergence between weakening economic activity and stubborn price pressures complicates the central bank's path forward, as traditional policy tools typically address one problem at the expense of the other.
A prolonged government shutdown played a significant role in the fourth quarter's economic underperformance. The 43-day closure of federal operations weighed heavily on economic activity, with the Congressional Budget Office estimating that such a shutdown could reduce annualized real GDP growth by between 1.0 and 2.0 percentage points in the quarter. The Federal Reserve had previously anticipated approximately a 1 percentage point reduction in growth due to the shutdown's effects.
Federal Reserve officials remain in a cautious stance, with minutes from the February Federal Open Market Committee meeting revealing sharp divisions among members regarding the future trajectory of monetary policy. While almost all participants supported holding interest rates steady in January, discussions in February showed a split among those advocating for rate cuts, those favoring maintaining current levels, and a group considering the possibility of further increases.
The Fed continues to prioritize inflation data while monitoring labor market conditions. Some analysts, including those at TD Securities, anticipate quarterly rate cuts of 25 basis points later in 2026, though they expect the central bank to remain on the sidelines in the near term as policymakers assess whether the economic slowdown proves transitory or more sustained.
The unexpected uptick in core inflation, occurring alongside a dramatic growth deceleration, suggests that the Fed may need to maintain restrictive policy for longer than previously anticipated, even as economic activity weakens. This challenging environment places heightened importance on upcoming economic data releases, which will provide crucial signals about whether the fourth quarter's weakness represents a temporary setback or the beginning of a more pronounced economic slowdown.