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Second-quarter U.S. GDP to slow sharply on tax burden

By Lucia Mutikani

WASHINGTON (Reuters) - Economic growth probably slowed sharply in the second quarter, but its pace is unlikely to change views that the Federal Reserve will start trimming bond purchases later this year.

Gross domestic product probably grew at a 1.0 percent annual rate after expanding at a 1.8 percent pace in the first quarter because government austerity and weak global demand weighed on the economy, according to a Reuters poll of economists. But there is a risk that growth undershoots expectations, with forecasts as low as a 0.4 percent rate.

If economists are right, it would mark a third straight quarter of GDP growth below 2 percent, a pace that normally would be too soft to bring down unemployment.

The slowdown is expected to be temporary, with an acceleration in output forecast for the rest of 2013 as the drag from higher taxes and deep budget cuts wanes.

The Commerce Department will release its advance report on second-quarter GDP at 8:30 a.m. EDT (1230 GMT) on Wednesday. The data will come as the Fed prepares to wrap up a two-day meeting, but economists do not expect the report to have much influence over how Fed officials think about the fate of the $85 billion per month bond-buying program.

"GDP tends to be backward looking," said Dan North, lead economist at Euler Hermes Americas in New York. "The Fed is looking more intensively at the labor market measures which have firmed quite a bit in the last three months, which is why there is an expectation that they will start tapering in September."

Fed Chairman Ben Bernanke has said the U.S. central bank expects to start cutting back the purchases later this year, and would likely bring them to a complete halt by the middle of 2014, if the economy progressed as it expected.

U.S. financial markets have already priced in a weak second-quarter GDP report. Attention will be on comprehensive revisions to GDP data, which among other changes now treat research and development spending as an investment.

BIGGER ECONOMY, HIGHER SAVINGS?

Other changes are the inclusion of more ownership transfer costs in investment and measuring defined benefit pension plans on an accrual basis rather than cash. Analysts say these changes will not only reveal a bigger economy and a higher rate of savings, but could help revise fiscal 2012 growth upward.

"It looks like these revisions will be modestly favorable for GDP growth on net," said Michael Feroli, an economist at JPMorgan in New York.

Economists said the revisions would probably narrow the gap between a relatively strong pace of job gains and weak growth.

The weak pace of second-quarter growth will reflect a sharp slowdown in consumer spending caused by higher taxes at the start of the year and an unwinding of utilities spending, which was boosted by unusually cold weather in the first three months of the year.

Consumer spending, which accounts for more than two-thirds of U.S. economic activity, is expected to slow to a less than 2 percent pace after accelerating at a 2.6 percent rate in the first quarter.

Sluggish domestic demand likely made businesses cautious about restocking warehouses. A marginal contribution to second-quarter GDP growth is expected from inventory accumulation after restocking added more than half a percentage point in the January-March period.

Business spending on equipment and software likely held steady, with investment in nonresidential structures rebounding from the first quarter's decline.

The housing market probably remained a bright spot during the second quarter. Spending on residential construction is expected to expand at a pace similar to the first quarter. Homebuilding added to growth last year for the first time since 2005 and its recovery should help ensure the economy continues to expand, albeit at a modest pace this year.

Exports are expected to have dragged down growth as demand weakened in Europe and China. Trade is expected to have subtracted more than half-a-percentage point from GDP growth in the second quarter.

Government spending is expected to have contracted for a third straight quarter, largely because of the across-the-board government spending cuts, known as the sequester, which have hit the defense sector.

Other details of the report are expected to show that sluggish domestic demand is keeping a lid on inflation pressures.

(Reporting by Lucia Mutikani. Editing by Andre Grenon)

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