- The Washington Times - Friday, July 28, 2006

Economic growth fell by more than half to a 2.5 percent annual rate in the spring quarter as a surge in fuel prices to record highs helped precipitate a sharp downshift in spending by consumers and businesses and stoked the highest inflation in more than a decade.

Wall Street celebrated the news from the Commerce Department yesterday because it suggested the Federal Reserve already has accomplished the slowdown it has sought in its campaign to cool inflation. The Dow Jones Industrial Average surged by 119 points while market interest rates dipped in anticipation of fewer Fed interest-rate increases in the months ahead.

The more subdued growth resulted from a drop in consumer spending on housing, cars and other big-ticket items as well as big, unexpected pullbacks in exports and business spending on computers and equipment, which fell at a 1 percent rate.

Residential construction fell by 6.3 percent — the first major drop in housing’s contribution to the economy since 1995. Revisions by the department also showed that growth has been slower than thought throughout the expansion since 2002, partly because of higher inflation.

Despite the rise in inflation and a further surge in energy prices this summer, separate reports yesterday showed that consumer confidence has held up in part because wage growth picked up in the second quarter, with a 0.9 percent gain that was the best in three years, the Labor Department reported.

“Consumers are taking the run-up in gasoline prices in stride, apparently with the help of strong job and income gains,” said Aaron Smith, an analyst with Economy.com. A report from the Energy Information Administration yesterday found that U.S. drivers consumed a record amount of fuel during May despite the high prices.

“That consumers’ moods are even mildly upbeat given the laundry list of negatives — rates, energy, geopolitics — is encouraging from a growth perspective,” Mr. Smith said. He expects growth to pick up again in the summer quarter as consumers recover their composure.

While the spring declines in consumer spending and housing were widely expected, economists were surprised by the sudden downshift in business investment spending and exports. Most had expected those two strong sectors of the economy to fill in for what many project will be prolonged weakness in housing and slack in consumer spending.

The unexpected pullback in the business sector should make the Fed more cautious because it suggests further rate increases could do substantial damage to the economy and imperil the expansion, some economists said.

“It shows a lopsided picture,” said Joe Carson, an economist at AllianceBernstein Holding LP. “That’s a warning sign to the Fed that growth has already slowed.”

Senior economist Christian E. Weller of the Center for American Progress said, “With consumer spending slowing, businesses apparently have fewer incentives to spend their money on new plants and equipment.” He noted that rather than finding ways to put their profits to work, most companies are hoarding cash, sending the share of corporate cash assets — at 6 percent — to the highest level in 40 years.

Consumers will not be able to stage a strong rebound in the second half, even if they want to, Mr. Weller said, because they have gone into unprecedented levels of debt to finance their spending binge in past years. Yesterday’s Commerce Department report showed consumers through borrowing spent far more than they earned in the last quarter — sending the savings rate to a record low of minus 1.5 percent.

“To revive U.S. economic growth, consumers need to find a way to raise their spending without going deeper into debt,” Mr. Weller said. “This can only come about if more jobs are created and workers see real wage gains.”

The Labor Department report showing a strong 3.4 percent wage gain in the past year, after adjusting for inflation, provides a glimmer of hope that incomes are growing enough to support consumers’ spending desires, he said.

“The critical question, is if these apparent, albeit small, improvements can be sustained in the face of a Federal Reserve determined to slow the economy through higher interest rates,” he said.

Other economists said the wage gains and jump in inflation seen in the Commerce Department report are red flags that may keep the Fed in an anti-inflation mode. The report showed inflation running at 4.1 percent last quarter. Even excluding high energy and food costs, “core” prices leaped by 2.9 percent, the highest since 1994, from 2.1 percent in the first quarter.

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