GDP comes in strong. But will 'fiscal cliff' slow growth?

The economy grew at a 2.7 percent pace in the third quarter, according to the latest GDP report, but the road ahead depends heavily on how politicians deal with the fiscal cliff.

The US economy grew at a 2.7 percent pace in this year's third quarter, a stronger showing than had originally been estimated.

The new tally, released Thursday, came after the Commerce Department had reported a month ago that the third-quarter growth rate was just 2 percent.

Although stronger growth is better than deceleration, the latest report on gross domestic product comes with two big caveats.

First, the upward revision came because of a spike in inventories – goods that were produced but not sold during the quarter. Yes, that stocking-up may have helped companies when those Black Friday shoppers rolled in, but that kind of gain can't be repeated quarter after quarter unless the production is matched by a rise in consumer demand.

Second, the road ahead depends heavily on dealing with the "fiscal cliff" – what President Obama and Congress do about the scheduled tax hikes and federal spending cuts that are poised to affect consumption in the new year.

"A slowing trend already looks likely in the fourth quarter due to storm disruptions and because business confidence has sunk to its lowest for a year, hit in particular by uncertainty caused by the looming fiscal cliff and ongoing worries about the euro zone crisis," economist Chris Williamson of Markit wrote in an analysis Thursday.

Even if the White House and Congress reach a deal that prevents steep tax hikes on consumers in January, that doesn't mean there will be no "cliff" effect. Negotiations in Washington are focused on a twofold goal: keeping the economy from being pushed suddenly into recession, while also laying a medium-term plan to reduce federal deficits.

Thus a fiscal bargain would probably include some tax hikes compared with current policy. That means some "austerity" for an economy that's not growing very fast.

The new third-quarter numbers, for example, show "final sales" to households and businesses rising at a 1.9 percent annual rate, adjusted for inflation. That's growth, but doesn't represent a buoyant recovery.

The pace of growth in the second quarter was just 1.3 percent, and the fourth quarter could come in at 1 to 2 percent, forecasters say.

Mr. Williamson says he doesn't expect the upward revision of third-quarter GDP to have any effect on Federal Reserve monetary policy. "Any renewed weakness ... will subdue hiring," he writes, meaning the Fed's efforts at monetary stimulus are "likely to remain in place for some time to come."