US Q2 growth revised up, Fed still seen in play

Reuters: The U.S. economy fared slightly better than initially thought in the second quarter, but the pace of growth remained too slow to shut the door on further monetary easing from the Federal Reserve.

Gross domestic product expanded at a 1.7% annual rate, the Commerce Department said on Wednesday, as stronger export growth offset a pull-back in restocking by businesses wary of sluggish domestic demand.

While that was an improvement on the government’s first estimate of 1.5% published last month and the composition of growth was fairly favorable, it was insufficient to cut into an unemployment rate that ticked up to 8.3% in July.

The lack of stronger job growth, along with the uncertainty stemming from Europe’s debt crisis and fears of big U.S. government spending cuts and tax hikes in 2013, could compel the U.S. central bank to offer additional stimulus by year end.

“I don’t think this really changes the dovish sentiment of the Fed,” said Michael Hanson, a senior economist at Bank of America Merrill Lynch in New York. “They are going to look at this and say 1.7% is below trend, that’s not where we want to be and the risks going forward are still material.”

A growth pace of between 2% and 2.5% is generally seen as needed just to hold the jobless rate steady, and the sluggish recovery is proving to be a difficult hurdle for President Barack Obama in his quest to secure a second term in November’s election.

Growth in the third quarter is expected to show an improvement, but still remain below the economy’s potential.

A second report showed contracts to buy previously owned homes hit their highest level in more than two years in July, suggesting the housing market’s recovery was gaining traction and offering a relative economic bright spot.

The lackluster recovery has sparked a sharp debate among Fed officials over whether they should launch another round of bond purchases to spur stronger growth.

Economists say the outcome of the central bank’s next meeting on September 12-13 will be a close call. Jobs growth has picked up a bit and housing and retail sales have strengthened. However, business spending looks weak and inflation is slowing.

Fed Chairman Ben Bernanke could offer more clarity on the outlook for monetary policy when he speaks at a gathering of central bankers in Jackson Hole, Wyoming, on Friday.

“Growth is neither strong enough for Bernanke to take any additional easing off the table, but it is hardly weak enough to force him to announce new actions,” said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

The Fed’s Beige Book report, which offers a snapshot of the economy, described economic activity as continuing to “gradually” expand in July and early August. It noted, however, that manufacturing activity was softening in many regions of the country.

Stocks on Wall Street were little changed for a third straight day as investors opted to wait for Bernanke’s speech. Treasury debt prices fell, while the dollar eked out modest gains versus a basket of currencies. The revised GDP data showed export growth was strong, while import growth was the smallest in a year. Trade contributed 0.32%age point to GDP growth instead of subtracting a third of a point, as previously reported.

“We expect softer export growth over the coming quarters, but not a collapse because the majority of exports stay in North America (and) will be insulated from what’s going on in Europe and China,” said Paul Edelstein, an economist at IHS Global Insight in Lexington, Massachusetts.

The export strength helped to offset the drag from inventories. However, the careful management of stocks could be a boost to the economy in the third quarter.

Excluding inventories, GDP rose at a 2.0% rate rather than 1.2%.

Consumer spending, which accounts for about 70% of U.S. economic activity, was revised up a notch to a 1.7% pace from the previously reported 1.5%. Still, that marked a step-down from the first quarter’s 2.4% pace, and a smaller rise is expected this quarter with demand for big-ticket items such as automobiles cooling.

Stronger than previously reported investment in the construction of nonresidential structures also gave a lift to GDP growth in the second quarter.

But growth in business investment in equipment and software was lowered to a 4.7% pace, the slowest since the third quarter of 2009, from 7.2% previously.

Growth in spending by businesses on equipment and software has slowed sharply from a peak of 18.3% in the third quarter of last year, and the retrenchment appears to have intensified early this quarter.

“There’s no question that as we look toward the end of the year and the risk presented by federal spending cuts and tax increases, the economy remains in a vulnerable window,” said Jim Baird, chief investment strategist at Plante Moran Financial Advisors in Kalamazoo, Michigan.

The report also showed that after-tax corporate profits rose at a 1.1% rate after sinking 8.6% in the first quarter.

Government spending declined, but the drop was not as deep as previously reported. And even though consumer spending was bumped up, inflation pressures remained muted.