Economy picked up in early 2026, but inflation jumped, too

The U.S. economy grew at a 2 % pace in the first three months of the year, as higher investment and a rebound in government spending buoyed business activity while consumers showed signs of fatigue amid rising prices.

Growth accelerated from the previous quarter, which was hurt by the longest government shutdown in history, according to the Commerce Department report on gross domestic product, the sum of goods and services made in the United States. But it fell short of Wall Street analysts’ expectations of 2.2 % growth and is running below the Congressional Budget Office’s estimate of the economy’s potential to grow without aggravating inflation.

The news on inflation was worrisome, according to a separate government report. Prices in March were 3.5 % higher than one year ago, according to the Federal Reserve’s preferred price gauge, the personal consumption expenditures index. Excluding volatile food and energy costs, the index rose by 3.2 % up from 3 % in February.

With prices rising faster than its 2 % target, the Fed left its benchmark lending rate unchanged Wednesday.

Higher export sales also contributed to the economy’s growth. But imports, which are effectively subtracted from the GDP calculation, rose as businesses rushed to stock up on imported goods following the Supreme Court’s February ruling invalidating much of President Donald Trump’s tariff agenda. The merchandise trade deficit grew to $87.9 billion in March, up more than 5 % from the previous month, the Census Bureau said Wednesday.

“The underlying trend in GDP growth remains solid,” said economist Michael Strain of the American Enterprise Institute. “Worryingly, today’s release also showed clear signs of inflationary pressure.”

The impact of the war in Iran, which began on Feb. 28, contributed to that pressure. The prolonged interruption of oil and gas shipments through the Strait of Hormuz drove up the price of gasoline, diesel fuel, natural gas and jet fuel. Regular gasoline now averages $4.30 per gallon, a four-year high, according to AAA.

Consumers dialed back their spending on goods while continuing to spend on in-person services, such as sporting events or restaurant meals. But a surge in business spending on new equipment, up more than 17 % from the preceding quarter, and software drove the overall economy.

Much of that spending is linked to the continuing boom in artificial intelligence, which has been a clear bright spot for the economy.

As U.S. technology giants continue spending freely on the giant data centers needed to power AI, prices are rising across the electronics sector, according to Michael Pearce, an economist with Oxford Economics.

On Wall Street, stocks rose less than 1 % in midday trading. Thursday’s Commerce Department GDP snapshot will be revised at least two more times as government statisticians gather additional data.

The $31 trillion economy continues to power through a series of shocks that have weighed on the production of goods and services. Over the past five years, the pandemic, Russia’s invasion of Ukraine, the president’s tariff and immigration policies, and the conflict with Iran all have hurt growth and boosted inflation.

Growth in real final sales to private domestic purchasers, which some economists say is a better measure of economic health, rose in the first quarter to 2.5 % from 1.8 % one quarter earlier. Fully half of that increase came from computer and software purchases tied to the AI build-out, according to Pantheon Macroeconomics.

The economy entered the year with little forward momentum. Growth slid to just 0.5 % in the last three months of 2025, hobbled by a 43-day government shutdown. The anemic figure marked a sharp decline from the 4.4 % pace achieved between July and September.

But Trump administration officials forecast a rapid turnaround, with Treasury Secretary Scott Bessent predicting a “great year” as the administration’s tax cuts and deregulation initiatives take hold.

Still, some economists said the economy is resting on a narrow base of AI investment and spending by higher-income households.

“Activity is holding up, but increasingly at the cost of higher inflation and rising vulnerabilities,” said Gregory Daco, chief economist for EY Parthenon.

Amid consecutive monthly declines in inflation-adjusted personal income, consumers have been relying on tax refunds and dipping into savings to maintain their lifestyles. Rising stock values have supported spending by higher-income households. Over the past month, the S&P 500 index gained more than 12 % and is up more than 4 % so far this year.

But consumer spending, which accounts for roughly 70 % of the economy, will probably weaken in May, once income tax refunds fade, said Samuel Tombs, chief U.S. economist for Pantheon Macroeconomics.

In March, higher gas and other energy costs accounted for nearly half of the monthly increase in consumer spending, according to the Commerce Department.

“The tax refunds were good news, certainly for households. But in real terms, there was not much left. Come May, June, July, we’re going to start seeing a sadder summer,” said Beth Ann Bovino, chief economist for U.S. Bank.

Mortgage rates above 6 % are keeping a lid on housing activity. And the labor market has settled into a no-fire, no-hire calm. Employers over the past year created just 260,000 jobs.

On Wednesday, Powell told reporters that the effects of the Iran war on the U.S. are “substantially less” than on Europe and Asia. But with inflation perking up and growth subdued, Americans may soon confront a darkening economic landscape.

“We’re moving towards an adverse scenario where the economy could grow less than 1 % and should the conflict escalate, a recession is in the cards,” said Daco. “So we’re in this fragile state where economic activity is likely to decelerate as we navigate through the year.”