Economy's 'soft patch' deeper than expected

Reluctant consumers and record-high crude oil prices, at $43.85 a barrel, affect GDP growth - and election campaign.

It's time to worry about the economy, again.

Consumers are balking about pulling out their wallets, particularly to buy new cars. Paychecks for low-wage workers are not keeping up with inflation.

And the price of crude oil has spiked up yet again to a new record high of $43.85 a barrel. Call it "Shock at the Pump: The Sequel."

If the economy doesn't kick into a higher gear, it won't have enough oomph to create more jobs, and the unemployment rate might actually begin to climb. The slower-paced economy, which will be especially noticeable in the industrial Midwest, also gives the Democrats room to criticize President Bush. And it may call into question how fast the Federal Reserve raises interest rates this year.

"Clearly, the concern for economic growth now and in the future has increased," says Sung Won Sohn, chief economist for Wells Fargo Banks in Minneapolis.

The impetus for the new economic worries came last Friday when the Commerce Department reported the nation's gross domestic product (GDP) grew at a 3 percent annual pace, a number that economists considered to be disappointingly soft. The first quarter was revised upward to 4.5 percent, making the drop-off look even sharper.

"The soft patch is deeper and bigger than we anticipated," says Mr. Sohn. Because of the timing, the economic slowdown has political ramifications. The Kerry campaign says it's not just focusing on one quarter. But Phil Singer, a spokesman, adds, "Clearly the current administration's management of the economy is not getting the job done."

In Washington, John Snow, the Treasury secretary, said the economy was on a "positive track" and the fundamentals were "solid for the future."

Outside economists, however, thought the administration was probably unhappy with the latest news.

"Three percent is uncomfortably weak for the president," says Mark Zandi of Economy.com. "It's not going to generate enough jobs to get the unemployment rate down."

Economy could still accelerate

Yet some economists also think the economy has already started to accelerate. By some estimates the second half of the year will see the economy buzzing along at as much as 4.5 percent annualized growth. The optimists believe business spending and a return of the consumer will drive the economy.

The first indication of whether that's true will come on Friday, when the Labor Department issues the July employment report. The consensus is that the economy added about 200,000 jobs last month. If job growth is considerably weaker, many economists will start to ratchet down their estimates for the second half of the year.

Job growth could be better

Any slowdown in the jobs arena will also catch the attention of the Fed, which meets to discuss the economy and interest rates on Aug. 10.

Most interest-rate observers expect the Fed will consider the second quarter to be the low-water mark for the economy, because the consumer was beset by high prices at the gas pump, the effect of the tax cuts was less than expected and mortgage refinancing slowed down.

"They have articulated that they want to move from the extreme easing of 2002 and 2003," says Scott Pedowitz, a fixed-income strategist for Commerzbank Securities in New York. "By the end of the year, the Fed funds rate will be back to 2 percent (from 1.25 percent now)," predicts Mr. Pedowitz, who anticipates the central bank will raise rates by another quarter of a percent.

Greenspan at the car dealer

Fed chairman Alan Greenspan is also probably going to start to visit car showrooms to see how well Detroit's offerings are selling. In the beginning of the second quarter, many companies had removed or reduced their incentives to buy cars. Detroit's inventories rose to 72 days, 16 percent above average.

"Americans are waiting for a better deal," says Jose Rasco, an economist at Merrill Lynch & Co. "Every time they boost incentives, Americans buy."

They won't have long to wait. In June, Edmunds.com, an online resource for auto information, reported the average incentive per vehicle reached a record $2,747, up $123 from last year and $240 over this May.

In the New York metro area, incentives ranged from 40 percent off all payments through Columbus Day at Nemet Motors in Queens to $10,000 off the list price for an Eddie Bauer Ford Expedition at Wantagh Ford in Wantagh, N.Y.

Those temptations are essential, says Richard Curtin, director of the University of Michigan's Survey of Consumers. On Friday, the University released its latest survey which showed consumers optimistic about almost everything but buying a new vehicle.

"I think it's largely because consumers had thought gas prices would go down rapidly, but now they have concluded they are going to stay at this level for a good long time and it's affecting their decisions," says Mr. Curtin.

Moving the cars will be essential, not just for the economy, but also for President Bush. Many cars and auto parts are built in Ohio, Michigan, West Virginia, and Pennsylvania. "It would not be a good thing to have rising layoffs in a swing state," says Curtin.

One of the key areas that may determine whether consumers return to the lots will be the price of gasoline.

Last week, the price spiked up sharply on concerns that the Russian oil company Yukos would not be allowed to export oil because of a tax dispute it's having with the government. "Rising energy prices are the key risk to the economy and the president's reelection," says Mr. Zandi. "If energy prices spike, people will feel it and it will play out politically."

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