Second Quarter Economic Growth Revised Up, but Turbulence Lies Ahead

By Jason Simpkins
Associate Editor

The U.S. economy grew at a much faster pace than originally estimated in the second quarter, but that growth will likely stall in the second half of the year, as consumer spending and overseas demand continue to wane.

Gross domestic product (GDP) expanded at an annual pace of 3.3% in the second quarter, up from the Commerce Department's initial 1.9% estimate and a strong improvement over the first quarter's 0.9% pace. However, GDP growth was bolstered largely by record exports and $92 billion in government tax rebates.

Final sales increased 4.8% from April to June, but are beginning to slip as the effect of the government stimulus checks wears off. Retail sales actually declined in July for the first time in five months, and are likely to decline further as unemployment continues to rise.

The United States has lost 463,000 jobs this year and wages are struggling to keep pace with inflation. The unemployment rate accelerated to 5.7% in July, up from 5.5% the month prior.

The Labor Department yesterday (Thursday) indicated initial jobless claims fell by 10,000 to 425,000, but the number of people remaining on unemployment rose to 3.4 million – the highest since November 2003.

"The labor market may continue to weaken," Russell Price, a senior economist at H&R Block Financial Advisors Inc. (HRB) told Bloomberg. "It's become clear that second half growth isn't going to be as strong as the first half, so businesses are going to finally start to trim payrolls a little more."

Meanwhile inflation climbed 4.2% in the second quarter and continues to bite into wages. Wages and salaries grew just 0.7% and benefit costs advanced 0.6%

"Both wage and salary growth and benefit growth have been decelerating in recent quarters after reaching fairly modest cyclical peak in late 2006/early 2007 because of the loosening in the labor markets," Insight Economics analyst Steven Wood told The Wall Street Journal. "Further deceleration is likely as the labor markets continue to weaken."

Export growth, which was the biggest contributor to second-quarter growth, may also decline substantially in coming months as two of the country's biggest trading partners –Europe and Japan – show continued signs of weakness.

Exports jumped 13.2%. The trade gap receded to an annual pace of $376.6 billion as a result and added 3.1 percentage points to growth – the most since 1980.  But those figures will surely take a hit in coming months, as the economies of both the European Union and Japan shrank last quarter.

The Eurozone economy recorded its first decline in more than a decade in the second quarter, contracting at a 0.2% pace. The broader 27-nation European Union economy shrank 0.1% in the second quarter.

Japan's GDP fell 0.6% from the previous quarter, which translated into a 2.4% annualized rate of decline. The drop was the biggest in nearly seven years, as rising prices of energy, food and raw materials hit consumers and corporations.

"With the world economy slowing, we shouldn't expect exports to add nearly as much to growth," said Joel Naroff president and chief economist for Naroff Economic Advisors. "The question is, while the economy apparently expanded strongly during the spring, what does this mean for the second half of the year?"

At its June 24-25 meeting, the Federal Open Market Committee (FOMC) kept its target for the federal funds rate at 2%, but the committee "marked down" the central bank's forecast for economic growth in the second half 2008 and 2009, according to the minutes of the Federal Open Market Committee's Aug. 5 meeting.

"Although the increase in real GDP in the second quarter was a bit faster than anticipated at the time of the June meeting," the minutes said, "the labor market continued to weaken significantly, financial conditions remained unfavorable, consumer and business confidence was downbeat, and manufacturing activity was contracting."

The central bank predicts 2008 growth will come in between of 1% and 1.6%.

News and Related Story Links:

• Money Morning:
  2Q GDP Buoyed by Exports and Rebate Checks

• Money Morning:
  Weak Exports and Domestic Spending Declines Push Eurozone to the Recessionary Brink

• Bloomberg:
  U.S. Economy: GDP Exceeds Initial Estimate on Exports