Fri Jul 30, 2004
By Victoria Thieberger

NEW YORK (Reuters) - Consumer spending should pick up again in coming months as the job market improves and incomes rise, after Americans uncharacteristically turned frugal in the second quarter, economists say.

High oil prices bore much of the blame for the unexpectedly modest 1.0 percent increase in consumer spending in the quarter ended in June, the weakest pace since the 2001 recession. It was around half of Wall Street's expectations.

"Income generation in the economy remains pretty strong right now and employment is starting to pick up, so we think consumer spending will bounce back," said Wachovia economist Jay Bryson.

While more recent data for July suggests consumption picked up in recent weeks, the one caveat is that the economy could face renewed headwinds from the latest surge in energy costs.

Oil futures touched a fresh record above $43 on Friday, but the spike has not yet translated into a renewed increase in gasoline prices, which could crimp spending.

Bryson sees moderate spending growth of 2.5 percent to 3.0 percent going forward, still below the robust 4.1 percent rate of the first three months of the year. He said he may rethink that estimate if gasoline prices start to reflect the latest oil spike.

Consumer spending is critical because it accounts for around two-thirds of U.S. economic activity. In addition, businesses need to be sure that demand will hold up before they invest in new equipment and capacity.

Figures on Friday showed overall economic growth, as measured by gross domestic product, rose a below-trend 3.0 percent in the April-June quarter, entirely due to the softness in household spending.

Indeed, final sales, which exclude inventories, have been on a steadily declining trend for the past year, falling from a 6.8 percent growth rate in last year's third quarter to 3.7 percent, 3.3 percent and 2.8 percent in the latest quarter.

HEADING FOR FIRMER GROUND

The economy is slowing as the massive amount of policy stimulus of the past couple of years ends: the third and last round of income tax cuts have been spent and the Federal Reserve began raising official interest rates on June 30 after more than two years of super-low interest rates.

But much of the economic weakness seems to have been confined to a summer pause in June, and Fed Chairman Alan Greenspan told Congress earlier this month the softness would prove temporary.
He said auto sales had picked up, and General Motors has since confirmed an improvement from dreadful June sales, while weekly chain store sales have also improved lately.

"Early indications are that the economy is moving out of the soft patch and stepping onto firmer ground," said Sung Won Sohn, chief economist at Wells Fargo. "Detroit has boosted incentives and vehicle sales are responding positively, and housing-related activities are in the process of setting another record in 2004."

Economists do not see the softer GDP report deterring the Federal Reserve from an expected quarter-point hike in official interest rates at its Aug. 10 meeting. But financial markets are less sure that the central bank will proceed to tighten policy at every meeting this year.

Before the August meeting, Fed officials will see the employment report and car sales for July, but not the next retail sales or inflation reports, noted FTN chief economist Chris Low.

"What that means is that there's not going to be much reassurance about the state of the consumer between now and when the committee sits down," he said.

While he still expects a rate rise, "it won't be the easy decision it looked like just a few weeks ago."

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