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August 1, 2006 > Growth throttles back to less than half the pace of prior quarter

Growth throttles back to less than half the pace of prior quarter

by Jeanine Aversa, AP Economics Writer

WASHINGTON (AP), Jul 28 _ A recipe for slower economic growth:

Ingredients: surging energy prices and higher interest rates.

Mix well and watch consumers and businesses grow cautious.

The end result: a throttling back of the economy in the second quarter to less than half the pace of the previous three months.

Still, Wall Street rallied on the hope that a break in two years of interest-rate pain might be in sight.

The nation's gross domestic product advanced at an annual rate of just 2.5 percent in the April-to-June period, according to Friday's economic snapshot released by the Commerce Department.

That was a big slowdown from the first quarter's lively 5.6 percent growth rate _ the fastest in 21/2 years _ reflecting energetic spending and investment by people and businesses alike.

But in the second quarter, Americans felt the pinch of $3-a-gallon gasoline prices and higher interest rates.

"This expansion is getting a little frayed around the edges because of consumer exhaustion," said economist Ken Mayland of ClearView Economics. "Consumers are losing that extra mojo to spend" now that the slowing housing market is making people feel less wealthy, he said.

Investors liked the news. The Dow Jones industrials gained 119.27 points to close at 11,219.70.

Spending on home building nose-dived in the second quarter, contributing to the slowdown in GDP, which measures the value of all goods and services produced within the United States.

The second-quarter's performance _ weaker than the 3 percent growth rate analysts were forecasting _ marked the slowest pace since the final quarter of 2005. That's when the economy, suffering fallout from the devastating Gulf Coast hurricanes, expanded at a feeble 1.8 percent pace.

Even though the economy cooled in the second quarter, inflation heated up.

An inflation gauge closely watched by the Federal Reserve showed that core prices _ excluding food and energy _ advanced at a 2.9 percent pace in the second quarter _ far outside the Fed's comfort zone. That was up from a 2.1 percent growth rate in the first quarter and marked the highest inflation reading since the third quarter of 1994, when core inflation rose at a 3.2 percent pace.

The inflation reading was taken before the latest run-up in energy prices. Oil prices, which had hit a record high in late April, soared to a new closing high of $77.03 a barrel in the middle of July.

In a separate report mined for inflation clues, the Labor Department said employers' costs to hire and retain workers climbed 0.9 percent in the second quarter, up from a 0.6 percent advance in the prior quarter.

Federal Reserve Chairman Ben Bernanke told Congress last week that he is concerned about rising inflation, but he also said that the Fed believes moderating economic activity will eventually lessen inflation pressures.

Given that assessment, Wall Street investors and some economists believe the Fed might take a breather in its two-year-old rate-raising campaign at its next meeting, on Aug. 8.

Some economists, however, continue to predict that rates will be boosted again at the August meeting to ward off rising inflation; after that, they think the Fed may move to the sidelines.

"This whole situation creates even more of a dilemma for Bernanke, who has to weigh the clearly slowing economy against accelerating and now uncomfortably high inflation," said Mark Zandi, chief economist at Moody's

On the one hand, the Fed doesn't want to hoist rates too much and cripple the economy; on the other hand, it doesn't want to take a respite too soon and let inflation get out of control.

The downshift in economic growth comes as President Bush is getting low marks from the public for his economic stewardship.

Consumers, a major force shaping overall economic activity, had a smaller appetite for spending in the second quarter. They boosted spending at just a 2.5 percent pace, down from a 4.8 percent growth rate in the first quarter. Much of that weakness reflected cutbacks on big-ticket goods such as cars.

Businesses also tightened the belt.

Spending on home building fell at a 6.3 percent pace in the second quarter, the deepest dip in nearly six years. Rising mortgage rates are clipping demand.

Businesses sliced spending on equipment and software at a 1 percent pace, the first cut in just over three years.

The government also issued annual revisions that showed the economy grew at an average annual rate of 3.2 percent from 2003 through 2005, or 0.3 percentage point less than previously estimated.

Growth in the second half of this year is expected to stay subdued at a pace of around 2.5 percent to 3 percent, some economists said.

Even with the second quarter's deterioration in growth, economists said chances of a more serious backslide into a recession remain fairly low at this point. "If you just looked at the deceleration from the first quarter, you would think the economy tanked," said Joel Naroff of Naroff Economic Advisors. "It did not."


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