Economy shows some verve

As growth remains strong and productivity shows signs of weakening, businesses will probably hire more workers.

The economy now seems poised for healthy growth for the rest of the year.

Propelling it is a mix of business spending on computers and software, orders from abroad on everything from combines to aircraft, and consumers undaunted by the cost of energy.

The continued economic recovery - now in its 45th month - should allow the Federal Reserve to continue its program of slowly raising interest rates. Solid economic growth, combined with slowing productivity, also means that the job machine will continue to keep the unemployment numbers relatively low.

The economic growth is good for the stock market: The Standard & Poor's average, for example, is close to a four year high. "America just continues business as usual," says Joel Naroff of Naroff Economic Advisors in Holland, Pa.

The latest evidence of this came on Friday when the Commerce Department released its first look at the gross domestic product in the April to June quarter. According to the government, the GDP grew at a 3.4 percent annual rate, following a 3.8 percent rate in the first quarter. If business had not reduced inventories, the GDP, a measure of the value of all goods and services, would have grown at nearly a 6 percent rate - the fastest pace in two years.

The growth came despite rising energy prices, which many expected to cut into consumer spending. In fact, on Friday, the price of oil remained above $60 a barrel, close to its noninflation-adjusted high point. Yet second-quarter consumer spending still rose by a respectable 3.3 percent, aided by special deals on automobiles.

The inflationary impact of higher energy bills could be seen in an inflation gauge that is part of the GDP. It rose at an annual 3.3 percent rate. But excluding food and energy, inflation was up only 1.8 percent in the second quarter.

"It says the Fed needs to tighten, but it can do it in a leisurely way," says Mark Zandi of Economy.com, an economic website. "Measured tightening is still firmly in place as a result of these reports." The Fed's next rate-setting meeting is Aug. 9, when it is expected to raise short-term rates another quarter of a point. That would put the federal funds rate at 3-1/2 percent. "They will hike it to 4 percent and then stop and see where we are," predicts Mr. Zandi.

Last quarter, the big change in the economy was the trade deficit. Exports increased while imports dropped, resulting in the largest dip in the trade deficit since 1947, when the government started tracking quarterly GDP. "We saw a pickup in capital spending, and it would appear more is being purchased domestically than imported," says David Huether, chief economist for the National Association of Manufacturers in Washington. "The likelihood of this continuing is not high. It's an anomaly."

Even if the trade deficit reverts back to its gloomy trend, analysts believe the economy will get a boost in the months ahead as businesses rebuild depleted inventories. General Motors, for example, has already removed many of its buyer incentives with its inventories in better shape. "What will they do next?" asks economist Anthony Chan of JP Morgan Asset Management in Columbus, Ohio. "Increase production."

In fact, Mr. Chan expects that the tempo of economic activity in the current quarter will increase slightly to 3.7 or 3.8 percent. "That seems very conservative given the huge inventory drawdown," he says.

If the economy has some bounce, analysts expect it to show up this Friday when the Labor Department reports the July jobless numbers. Some estimate as many as 180,000 new jobs were created in July, up from 146,000 in June and 104,000 in May.

The number of working Americans could start to rise, says Chan, because he believes productivity is slowing. When the government reports second-quarter productivity numbers early this month, he expects the growth rate to be about half what it was in the first quarter.

Still, by September, many economists feel the economic momentum will start to slow. "Business is worried: It's staring at narrowing profit margins," says Ken Goldstein, an economist at the Conference Board in New York.

Mr. Naroff predicts the pace will slow to under 3 percent by year end as the trade deficit widens again, business slows its ordering of new computers and software, and the housing market tails off with rising interest rates. "It's not terrible given the 3.5 percent rate in the first half," he says. Even if the economy does slow by year-end, the economic expansion will be intact. So far, it's lasted 16 calendar quarters. The average expansion is 23.6 quarters.