Economy downshifts

Second-quarter growth rate was a slower-than-expected 1.1 percent, raising doubts about the recovery.

The turmoil on Wall Street is finally starting to show up on Main Street.

Consumers, perhaps worried about their jobs or retirement funds, are pulling back. As a result, the economy is now growing more slowly than expected.

The slowdown keeps alive the specter of a downturn again later this year. And even if the economy avoids another recession, it appears that any strong recovery will be delayed.

"It looks as if the stock market plunge has had a significant impact on consumers' willingness to spend, and economic growth will be stretched out," says Sung Won Sohn, chief economist for Wells Fargo Banks in Minneapolis.

The latest sign of weakness came Wednesday, when the government, in its first look at the nation's gross domestic product (GDP) in the second quarter, found that the economy had expanded at 1.1 percent, down from a 5 percent growth rate during the first quarter.

This slowdown is likely to cause consternation at the White House, where President Bush and his economic team have been trying to allay investors' concerns by telling them that the economy remains "fundam

entally" sound.

Now, Republicans face the prospect that job growth and industrial production won't be as robust as they had hoped in November. If economic statistics in the next few weeks continue to show this weakness, there may be ramifications for Federal Reserve policy and the value of the US dollar as well.

The weaker-than-expected numbers are causing some businesspeople to call for the Fed to lower interest rates. Even though the latest report, for example, shows that business investment grew for the first time in two years, it should have been stronger at this stage of the economic recovery, says Thomas Duesterberg, president of the Manufacturers Alliance/MAPI in Arlington, Va.

"We believe the Federal Reserve needs to lower key interest rates in order to shore up the recovery and to avoid a double-dip recession," says Mr. Duesterberg.

However, Lyle Gramley, a former Fed governor, says he doubts lower rates are on the Fed's agenda. He expects the economic and financial news may cause the nation's central bank to keep the status quo for a while longer, then raise rates. "The next move by the Fed is up, not down, " says Mr. Gramley, a senior economic adviser to Schwab Capital Markets in Washington.

Gramley thinks the economy is still on track for a modest recovery, starting in the third quarter. Key to this pickup, he says, will be consumers, watching their bank accounts expand because of lower interest rates.

Last week, for example, two-thirds of new mortgage applications were for refinancing. "This is an important channel to energize the economy," he says.

However, the GDP numbers seem to indicate that consumers, stung by the stock market and business scandals, are slowing down. Consumer spending grew at a 1.9 percent annual rate, down from 3.1 percent in the first quarter.

This drop in spending jibes with reports indicating that consumer confidence is falling. For example, the Conference Board numbers on Tuesday showed a sharp drop.

But sometimes movements in this index don't translate into lost sales. In fact, the National Retail Federation continues to predict that sales will increase 6 percent this year compared with last year.

"It sounds like an exciting number, but you don't have to do much to improve over last year," says Scott Krugman, a spokesman for the Washington-based federation.

This is a crucial time of the year for retailers. They are just starting to crank up their promotions for back-to-school sales. Many are making final preparations for the holidays.

That's what's happening at Cheyenne, Wyo.-based Sierra Trading Post, a catalog and Internet sales company, which heavily discounts such brand names as North Face and Sierra Design. At first, the company thought it was going to be a pretty good year. But in the last six weeks, the order flow has slowed enough to make the company more conservative.

"We've pulled back the amount of mailings to be more careful," says CEO Gary Imig. "We won't be as aggressive at trying to acquire new customers."

Levenger, an upscale catalog-sales company, is actually adopting the opposite strategy, but only because the price of paper has come down.

Steve Leeven reports the company is still getting a healthy number of orders, but consumers are cutting back on the size of the orders.

In Houston, one sign of the flagging economy can be found at NTT Electronics. The manager of the store, which sells high-end systems, says customers are unwilling to dip into their pocketbooks for an amplifier or speaker that would work with their system. "People can't eat stereos, TVs, and speakers," he says.

Despite Wall Street's turmoil, Americans have continued to buy cars, partly because of generous financing terms. Momentum Volkswagen in Houston says it has not seen much of a drop-off in sales, because the blue-collar workers who buy VWs don't have much money invested in the market. "These are people who just want to make sure their jobs are fine and their 401(k) plans are secure," says Dustin King, sales manager.

But, the Mercedes set does invest, and the downturn in the market has dropped sales by 20 percent, says Bill Barton, manager of a Houston dealership. One of his best selling points is that buying a new car will help pull you out of the stock-market doldrums. He's just taken his own advice, selling what was left of his sinking stocks and buying something tangible. "Instead of losing it all, I bought a big-ticket item," he grins. "A Harley Davidson."

• Kris Axtman in Houston contributed to this story.