Declining inventories crimp U.S. second-quarter growth, consumer spending surges

August 26, 2016 9:10 AM EDT

People hold Macy's shopping bags outside the store at the Herald Square location in New York, U.S., May 9, 2016. REUTERS/Shannon Stapleton

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By Lucia Mutikani

WASHINGTON (Reuters) - U.S. economic growth was slightly more tepid than initially thought in the second quarter as businesses aggressively ran down inventories, offsetting a spurt in consumer spending.

Gross domestic product expanded at a 1.1 percent annual rate, the Commerce Department said on Friday in its second estimate of GDP. That was modestly down from the 1.2 percent rate it reported last month and also reflected more imports than previously estimated as well as weak government spending.

"The very slight downward revision to second-quarter GDP growth isn't too concerning, especially given that the more recent data point to a strong rebound in the third quarter," said Steve Murphy, an economist at Capital Economics in Toronto.

The economy has made a strong start to the third quarter with the goods trade deficit narrowing sharply and residential construction rising in July. Demand for manufactured capital goods surged in July, indicating the prolonged downtrend in business spending is abating.

While retail sales were weak in July, a buoyant labor market should continue to support consumer spending. Growth is also expected to get a boost from businesses restocking warehouses after liquidating inventories in the second quarter.

The Atlanta Federal Reserve is currently forecasting third-quarter GDP rising at a 3.4 percent rate. The economy expanded at a 0.8 percent pace in the first quarter. It grew 1.0 percent in the first half of 2016.

Federal Reserve Chair Janet Yellen struck an upbeat note on the economy on Friday when she addressed the annual global central bankers' gathering in Jackson Hole, Wyoming.

Yellen said she believed the case for raising interest rates had been strengthened in recent months by the "solid performance of the labor market and our outlook for economic activity and inflation."

The U.S. central bank hiked interest rates at the end of last year for the first time in nearly a decade, but has held them steady since amid concerns over persistently low inflation. Most economists expect another rate hike in December.

U.S. stocks were trading lower, while the dollar was up against a basket of currencies. U.S. Treasuries were little changed.


The government also reported that after-tax corporate profits fell at a 2.4 percent rate last quarter after increasing at an 8.1 percent pace in the first quarter. Weak profits could limit an anticipated rebound in business spending.

With profits declining, an alternative measure of growth, gross domestic income, or GDI, increased at only a 0.2 percent rate in the second quarter, the weakest since the first quarter of 2013. GDI measures the economy's performance from the income side. It increased at a 0.8 percent pace in the first quarter.

Some economists said declining profits and business spending argued against the Fed raising interest rates.

"There is, to be clear, no recession on the horizon but the data also appear to reject the notion of growth accelerating into a need for higher interest rates from the Fed," said Steve Blitz, chief economist at M Science in New York.

"There is good reason for why interest rates are so low. It isn't just because of the Fed, there is a weaker demand for capital at play as well. As such, attempts by the Fed to raise rates will be met with slower growth."

Investment in inventories in the second quarter dropped a steeper $12.4 billion, instead of the $8.1 billion reported last month. That was the first decline since the third quarter of 2011 and resulted in inventories slicing off 1.26 percentage points from GDP growth, the largest drag in more than two years.

The hit from inventories was previously estimated to be 1.16 percentage points. It was the fifth straight quarter that inventories weighed on output. Economists say some of the inventory drawdown could be attributed to robust consumption.

Consumer spending, which makes up more than two-thirds of U.S. economic activity, rose at a brisk a 4.4 percent rate -- the fastest since the fourth quarter of 2014, instead of the previously reported 4.2 percent rate.

Though a second report on Friday showed an ebb in consumer sentiment in August as younger households worried about rising expenses, Americans were upbeat about the economy's prospects.

Some of the rise in demand in the second quarter was met with imports, which were revised to show them increasing rather than declining. Combined with a modest downward revision to exports, trade contributed one-tenth of a percentage point to GDP growth in the second quarter instead of 0.23 percentage point as reported last month.

Business investment was also weaker than initially estimated amid downward revisions to spending on equipment and nonresidential structures, which include oil and gas wells.

Business spending has declined for three straight quarters, hurt in part by lower oil prices, which have squeezed profits in the energy sector.

"The key factor behind the weak investment numbers, the collapse in drilling, is fading, so capital spending may grow in the third quarter," said Patrick Newport, an economist at

IHS Global Insight in Lexington, Massachusetts.

(Reporting by Lucia Mutikani; Editing by Andrea Ricci)

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