US economy 'has barely budged': 1.3 percent growth in GDP

According to the US Commerce Department, the US economy only grew at a 1.3 percent rate in the second quarter – an improvement over the first quarter, now estimated to have experienced only 0.4 percent growth, but a slower pace than many economists had expected.

Contributing to the economic malaise were a contraction of spending by state and local governments as well as a spending pullback by consumers hammered by rising food and gasoline prices.

As a result of the slow improvement in the economy, many economists are now lowering their outlook for the second half of the year, which had been expected to show more spunk. Without higher growth, business is unlikely to hire more people, which will keep unemployment high, say economists. In addition, if businesses sense the economy is slowing, they may pull back on ordering new equipment and building new factories.

“It is now clear: the economy is even less sturdy than we thought just one day ago,” says Richard DeKaser, economist at the Parthenon Group, a Boston-based consulting company.

The lackluster performance by the economy comes against the backdrop of the Washington debate over increasing the debt ceiling. Some economists are concerned that consumers and businesses are delaying purchases until they see how the impasse will be resolved. Many investors are starting to reduce their stock portfolios, with the Dow Jones Industrial Average off about 500 points in the past week including about another 60 points by noon on Friday.

Some banks, in an effort to conserve capital, are starting to tighten their terms and conditions for loans,says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla.

In addition, he notes some disruptions taking place in the capital markets, as investors start to pull money out of some money market mutual funds. According to Lipper Analytical, some $32 billion has been withdrawn from the money market funds so far this week.

“If there is not a deal by early next week, the government will have to prioritize its spending. The debt may get downgraded, and we could have all sorts of problems,” says Mr. Brown.

In the report released on Friday, the Commerce Department sharply revised downward its estimate of first-quarter growth, from an annual rate of 1.9 percent to 0.4 percent. “In other words, the economy has barely budged this year,” wrote economist Joel Naroff, of Naroff Economic Advisors in Holland, Pa

A major reason for the slow growth is a retrenchment by state and local governments, reflecting lower sales tax receipts and the reduction of the 2009 federal stimulus money. According to the report, real state and local governmen consumption and expenditures decreased 3.4 percent – the same decrease as in the first quarter.

Before Friday's report, economists had expected the US economy would rebound from the slowdown in auto production due to the earthquake and tsunami in Japan and the high gasoline prices. Instead, “we had some improvement, but not enough to offset other factors, especially the lack of spending by consumers and the lack of new hiring,” says Brown.

Part of the reason for the slowdown in consumer spending – which rose just 0.1 percent – was related to the dearth of Japanese vehicles to buy. Auto vehicle purchases declined by 23 percent in the quarter, according to an analysis by Austan Goolsbee, chairman of the Council of Economic Advisers in Washington.

That should start to improve, since many Japanese automobile manufacturers are now getting closer to normal production. However, gasoline prices are now up 17 cents a gallon over the past month, according to AAA.

With higher gas prices, lower stock prices, and the political maneuvering in Washington, consumer sentiment is eroding. On Friday, the Thomson Reuters/University of Michigan survey of consumers for July found consumer confidence has dropped to the lowest level in two years.

The uncertainty surrounding the debt-ceiling negotiations contributes to the decline in confidence, according to Barclay’s Capital Research. “The percentage of consumers describing economic policy as doing a ‘poor job’ has recently spiked,” said the report on Friday.