Slowing US economy likely to be boosted as Washington eases belt-tightening

Tighter fiscal policy and sluggish global demand, which has dampened exports, are seen as having hobbled the economy in the April-June period

US economic growth likely slowed sharply in the second quarter, but it is poised to regain momentum as the burden brought on by belt-tightening in Washington eases.

Gross domestic product probably grew at a 1.0 per cent annual rate, a step back from the first-quarter's 1.8 per cent pace, according to a Reuters survey of economists. Some said growth could be even weaker, with forecasts ranging as low as 0.4 per cent.

Tighter fiscal policy, a slow pace of inventory accumulation and sluggish global demand, which has dampened exports, are seen as having hobbled the economy in the April-June period.

“The economy only had a couple of legs to stand on, consumers and housing, but conditions are falling into place for a stronger second half of the year,” said Ryan Sweet, a senior economist at Moody's Analytics in West Chester Pennsylvania.

If economists' forecasts are proved right, it would mark a third straight quarter of GDP growth below 2 percent, a pace that normally would be too soft to bring down unemployment.

But given the backward-looking nature of the GDP report, it is not likely to have any impact on monetary policy.

Federal Reserve officials, wrestling with a decision on the future of their $85 billion per month bond-buying program, will probably nod to the second quarter's weakness when they wind-up a two-day meeting today. But they are also expected to chalk up much of the weakness to temporary factors, such as the drag from fiscal policy and a smaller build-up of business inventories.

Fed Chairman Ben Bernanke said last month that the central bank was likely to start curtailing the bond purchases later this year and would probably bring them to a complete halt by the middle of 2014, if the economy progressed as expected.

“Even with a relatively soft GDP number, the Fed still appears confident in their outlook and the prospects of the labour market going forward,” said Sam Bullard, a senior economist at Wells Fargo Securities in Charlotte, North Carolina. “It looks like they are positioned to make their announcement, come late this year.”

Silver lining in revisions?

While US financial markets have already priced in a weak second-quarter GDP reading, comprehensive revisions to the data might present a silver lining for the economy.

The government has implemented some changes in how it calculates GDP. For example, research and development spending will now be treated as investment, and defined benefit pension plans will be measured on an accrual basis, rather than as cash.

Economists say these changes will not only reveal a bigger economy and a higher rate of saving, but they could lead to an upward revision of 2012 growth as well.

“There's a distinct possibility that real GDP growth over the past four quarters will be upgraded,” said Maury Harris, chief economist at UBS in New York.

“In addition, history suggests that the originally published personal saving rate will be revised up, which would calm some concerns about under-saving consumers holding back their upcoming expenditures.”

Economists said the revisions would probably narrow the gap between a relatively strong pace of job gains and weak growth, a misalignment they said the Fed was monitoring.

Higher taxes, as Washington tries to shrink the government's budget deficit, likely constrained consumer spending in the second quarter, keeping the economy on an anaemic growth pace.

Consumer spending, which accounts for more than two-thirds of US economic activity, is expected to have slowed to a less than 2 per cent pace after rising at a 2.6 per cent rate in the first quarter.

That could bring the contribution from consumer spending far below the 1.8 percentage points it added in the first quarter.

With domestic demand tepid, businesses likely tried to keep their inventories from bulging. Inventory accumulation is expected to have made only a modest contribution to growth.

Other details of the report are expected to show exports weighed on the economy as demand weakened in Europe and China. Trade is expected to have subtracted more than half-a-percentage point from GDP growth in the second quarter.

Good news is expected from the housing sector, with double-digit growth forecast for spending on residential construction. Housing, which triggered the 2007-09 recession, is growing strongly, helping to keep the economic recovery anchored.

Business spending on equipment and software likely continued a steady march upward, with investment in non-residential structures rebounding from a decline in the first quarter.

Government spending, however, is expected to have contracted for a third straight quarter, largely because of the across-the-board spending cuts in Washington.

Reuters