Strong growth posted again

2nd-quarter rate of 5.2% defies forecast of slowdown

Inflation remains quiet

Surging economy raises fears of more Fed rate increases

July 29, 2000|By William Patalon III | William Patalon III,SUN STAFF

Despite economists' forecast of a slowdown, the relentless U.S. economy accelerated in the second quarter, though inflation remained in hiding and consumers tempered their red-hot spending, the government said yesterday.

Even so, the faster-than-expected growth touched off fresh fears of additional interest-rate increases by the Federal Reserve, which could spark a steep sell-off in stocks.

U.S. gross domestic product - the sum of products and services churned out within U.S. borders - grew at an annual clip of 5.2 percent in the second quarter, the Commerce Department said. That was faster than the 4.8 percent growth in the first quarter and soundly trounced the 3.8 percent estimate of economists.

Yesterday's GDP report is the latest in a flurry of recent reports that have economists searching high and low for a slowdown that seemed to be at hand two months ago.

"Rumors of a slowdown seem to be greatly exaggerated," said David Wyss, chief economist for Standard & Poor's/DRI, in Lexington, Mass. "You just can't keep a good economy down."

That isn't likely to keep the Federal Reserve from trying. Since late June 1999, hoping to slow growth to what it views as a more sustainable pace, the central bank has raised short-term interest rates six times and might do so again one or more times in an attempt to achieve that objective. The Fed's policy-making arm will hold its next meeting Aug. 22.

"Fundamentally, the economy has not slowed as investors had hoped or the Fed requires," said Charles Leiberman, an economist with First Institutional Securities. "It puts a tightening in August back on the table."

Because rising interest rates can weigh down share prices - eroding corporate profits or making other, fixed-income investments seem more appealing than volatile stocks - high-tech shares were punished by yesterday's resurgent interest-rate fears.

The technology-laden Nasdaq composite index fell 179.23 points, or 4.66 percent, to close at 3,663, in a sell-off that steepened late in the day. The Dow Jones industrial average dropped 74.96 points, or 0.71 percent, to finish the week at 10,511.17.

Despite yesterday's report, some economists said another interest-rate increase is not necessarily a foregone conclusion. Although the economy's second-quarter growth rate was about two percentage points faster than what Fed officials view as sustainable - at least, without sparking inflation - economist Richard Yamarone noted that evidence of inflation is nowhere to be seen.

"Diminishing inflation fears could mean the end of the Fed's tightening cycle," said Yamarone, director of economic research for Argus Research Corp. in New York City.

Mild inflation

For more than a year, even after the expansion eclipsed its earlier record length, inflation has been largely absent.

One key inflation indicator - the GDP price deflator, which is closely watched by institutional investors - grew at a 2.5 percent pace in the second quarter after rising at a 3.3 percent annualized rate in the first three months of the year, the government report said.

Another indicator, the personal consumption expenditure price index - watched by central bankers such as those at the Fed - rose at a 2.3 percent rate in the second quarter after a 3.5 percent increase in the first three months of this year.

Consumer spending, which accounts for two-thirds of the economy, slowed in the second quarter despite the pickup in growth, suggesting that "higher interest rates are bearing some fruit" and pushing down spending on big-ticket items such as automobiles, said Sung Won Sohn, chief economist for Wells Fargo & Co. in Minneapolis.

Consumer spending grew 3 percent in the second quarter, less than half the first-quarter pace of 7.6 percent, which was the fastest clip in 17 years.

Inventory buildup

Offsetting this slowdown was a big buildup in inventories, meaning businesses were replenishing stockpiles that had been depleted by consumers' first-quarter spending spree. Business inventories rose at an annualized rate of $60.3 billion in the second quarter, up from $36.6 billion in the first quarter.

That inventory buildup added a percentage point to the second-quarter GDP growth rate.

Businesses continued to invest in themselves, which not only boosts economic growth, but also helps make companies more productive. This productivity increase is largely credited for the economy's ability to grow at previously unheard-of rates, said S&P's Wyss.

Investment in equipment and software grew at a 21 percent rate in the second quarter, in line with the 20.6 percent pace of the first quarter. Those were the highest rates since the 24.6 percent growth rate of the first three months of 1998, and some economists say that suggests that innovations such as the Internet are boosting the country's economic efficiency at a pace not seen since the 1960s.

Wire services contributed to this article.

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