By Dr. Irwin Kellner, CBS MarketWatch.com
Aug. 3, 2004

HEMPSTEAD, N.Y. (CBS.MW) -- Not only was the second quarter's pace of economic growth much weaker than many people expected -- the third quarter's could be just as slow.

For one thing, the second quarter ended on a slow note. In the month of June, job growth slowed, while both retail sales and industrial production actually fell.

This means things had to have improved suddenly and markedly in July to put the third quarter back on track for faster growth. But it's unlikely that July was much different from June.

Accounting for two-thirds of the economy, consumers in June sharply pared back their spending, under pressure from higher energy prices and rising interest rates. Those jobs that were created in June tended to be lower paying than the ones that were lost.

A few more jobs may have been added in July, but consumers still had to deal with high energy prices and high interest rates. See our forecast page. Unseasonably cool, wet weather in many areas only added to retailers' woes.

Although only a few days old, August has brought forth another issue -- renewed fears of terrorism. And while these latest threats have focused only on Metro New York City and Washington, D.C., they might well cause consumers elsewhere to cut back -- at least for a while.

Meanwhile, businesses in the second quarter spent heavily on new capital goods, while adding to their inventories in the expectation that consumer spending was going to pick up.

Inventory building added 0.3 percentage point to the second quarter's growth rate, meaning that actual sales to final consumers were even weaker than the three percent increase in the top-line gross domestic product.

From an economics standpoint, this combination of stepped-up inventory accumulation and weaker consumer spending is not good news for those expecting a speedup in growth during the third quarter.

If consumer spending does not pick up substantially during the current quarter, business will reduce output even further to keep unsold goods from piling up on warehouse shelves. Even in today's low interest rate environment, it is still costly to stockpile more goods than are absolutely needed to take care of current sales.

When you add uncertainties over terrorism, the elections and the stock market into the mix, business is unlikely to go on a hiring spree anytime soon. This would nip in the bud the nascent improvement in consumer confidence, which appears to be based largely on improved job prospects.

June's so-called "soft patch" could well become this summer's briar patch.

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