The U.S. economy braked sharply in the fourth quarter of 2007, as the housing slump took a heavy toll.

U.S. GDP posted a weak 0.6% growth rate during the October to December period, the U.S. Commerce Department said today in the first estimate of fourth-quarter GDP.

Continuing problems in housing markets and tightening credit weakened growth, which Wall Street had widely expected to be 1.2% for the quarter.

This follows strong third quarter growth of 4.9%. The economy grew 2.2% for the whole of 2007, the lowest rate in five years—when GDP growth tumbled to 1.6% as the economy tried to recover from the 2001 recession.

Consumer spending slowed to just 2% growth, while expectations had pegged it at 2.7%. This was one of the major drags on growth, as spending accounts for about 70% of GDP.

“Looking ahead, we expect consumer spending to slow further in the first quarter of 2008, reflecting softer labour markets, elevated energy prices and declining house prices,” said Rishi Sondhi, an economist at RBC, in a note.

Housing was the other major drag. Residential construction fell 23.9% quarter-over-quarter, which follows a drop of 20.5% in the third quarter. And inventories also slowed growth, as businesses feared decreased demand from consumers and slashed inventories, which cut 1.25 points from GDP growth for the quarter.

Core inflation—which excludes the volatile food and energy prices—was a stronger-than-expected 2.7%. This “throws a wrench into the Fed’s decision calculus, as it suggests that inflation is not a variable that can be pushed to the back burner,” said Charmaine Buskas, senior economics strategist at TD Securities, in a morning note.

“There was some expectation that the Fed might push its inflation concerns to the back burner as the growth profile becomes increasingly concerning,” she added. “But it is clear that inflation continues to percolate and makes the scope for an aggressive spate of rate cuts less likely.”

Export growth also slowed, advancing at 3.9%, while imports were up only 0.3%, so net exports added a modest 0.41% to U.S. GDP.

“All-eyes now turn to the FOMC interest rate announcement later today, where the prospect of continued weak growth in early 2008 will probably see the Fed cut the policy-rate another 50 bps,” said Sondhi.