Late last year, business turned negative on the economy. There were concerns the Federal Reserve might hike interest rates to counter inflation and worries over the sharp drop in new home construction. As a result, this past winter many companies decided to reduce their inventories to be prepared for the worst.
That belt-tightening, combined with a slackening in exports, sapped the US economy in the first quarter. Those drags were apparent Thursday after the Commerce Department revised downward an earlier estimate of gross domestic product growth from 1.3 percent to 0.6 percent, the slowest growth in more than four years.
But economists believe that beneath the surface, the economy is stronger than the report suggests. Now that business sentiment is improved, the low inventories will give the economy a needed boost in the second quarter as they are replenished. In addition, US exports, boosted by a weaker dollar and stronger growth abroad, are picking up steam.
"On the surface it looks like the economy is dragging, but in reality it is not," says John Silvia, chief economist at Wachovia Securities Research in Charlotte, N.C. "The headline number looks weak or disappointing, but the underlying fundamentals look healthy."
From January through March, the chief driver of the economy was the consumer. The government reported that consumer spending rose by 4.4 percent, a pace that many economists don't think will continue in light of rising gasoline prices. GasPriceWatch.com reported Thursday that the national average for regular unleaded was $3.20 a gallon. This is up about 34 cents a gallon from a year ago, according to the Energy Information Administration.
"The rise in gasoline prices probably means a constraint in spending ahead," says Scott Brown, chief economist for Raymond James & Associates in St. Petersburg, Fla.
Even if consumer spending cools off, the economy will benefit from business replenishing its inventories. In the current quarter, economists expect the economy to grow at a moderate pace, about a 2.5 percent annual growth rate.
"No one is expecting the economy to roar back to life; it will still be a mixed picture," says Mr. Brown.
Most economists don't believe the economic weakness is likely to have much impact on the Federal Reserve, which meets on June 27 and 28. "In the minutes of the May meeting, Fed officials felt the GDP overstated the weakness in the economy," says Brown.
Instead, the Fed governors indicated they are more concerned about inflation. In fact, economist Scott Anderson of Wells Fargo Economics worries that the second half of the year may become a concern if consumers return to the malls. In a written comment about the GDP numbers Thursday, he said stronger growth than expected could prompt the Fed to raise interest rates later in the year.