US growth anemic, debt row poses recession risk

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By Lucia Mutikani WASHINGTON 

(Reuters) - The economy stumbled badly in the first half of 2011 and came dangerously close to contracting in the January-March period, raising the risk of a recession if a standoff over the nation's debt does not end quickly.

Output increased at a 1.3 percent annual pace in the second quarter as consumer spending barely rose, the Commerce Department said on Friday. In the first three months of the year, the economy advanced just 0.4 percent, a sharp downward revision from the previously reported 1.9 percent gain.

"The economy essentially came to a grinding halt in the first half of this year," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania. "We did get side-swiped by some temporary factors which are fading, but it raises some concerns about the sustainability the recovery."

The weaker-than-expected second-quarter reading and downward revisions extending into last year underscored the frail state of the recovery, which economists said could fall off the rails if lawmakers do not raise the nation's $14.3 trillion borrowing limit and avoid a government default.

Consumer spending, which accounts for about 70 percent of U.S. economic activity, decelerated sharply in the second quarter, advancing at only a 0.1 percent rate -- the weakest since the recession ended two years ago.

Stocks on Wall Street fell on the data and the debt impasse on Friday, to record their worst week in a year. Prices for government debt rallied, while the dollar fell broadly.



FUNDAMENTAL SLOWDOWN?

The Obama administration has said it will run out of borrowing authority on Tuesday and could soon run out of cash, but talks aimed at raising the debt ceiling remain deadlocked.

"This should wake up those in Washington who still have their thinking caps on," said Joel Naroff of Naroff Economic Advisors in Holland, Pennsylvania. "There is no margin for error and a default that lasted any length of time could push us back into recession."

But any debt agreement would include budget cuts that could also weigh on growth. High Frequency Economics said in a note on Thursday that a deal to trim the U.S. deficit would likely shave government spending by about $70 billion, or one-half of a percentage point of GDP, in its first year.

Growth in the first half of 2011 was held back by a combination of bad weather, expensive gasoline and supply chain disruptions after the earthquake disaster in Japan.

With economic activity yet to show signs of perking up, even with gasoline prices off their highs and the Japan supply constraints easing, there is concern that some of the weakness might be fundamental and linger for a while.

While economists still expect growth to accelerate to about a 3 percent pace for the remainder of this year and next year, the risks are stacked to the downside.

Annual revisions to GDP data that take into account newly available source material, including tax returns, showed the economy lost steam in late 2010, before it ran into the temporary headwinds. Fourth-quarter growth was revised to a 2.3 percent rate from 3.1 percent.

The revisions also showed the 2007-2009 recession was much more severe than prior measures had found.
The downgrades help to explain why the economy has only regained a fraction of the more than 8 million jobs lost during the downturn.

Economists said the current bout of weakness reinforced views that the Federal Reserve will maintain its accommodative monetary policy stance for a while, but few think the central bank will spring to the economy's rescue if it can avoid it.

"In the immediate environment, with so much at stake on fiscal policy, I think the Fed wants to remain quietly on the sidelines, sorting out events and how the data plays out in the second half of the year," said Robert DiClemente, chief economist at Citigroup in New York.

JOLT FROM JAPAN

The U.S. central bank has held interest rates close to zero since December 2008, and it has bought $2.3 trillion in bonds in an effort to further spur the economy. Fed Chairman Ben Bernanke has opened the door to a further easing of monetary policy, but officials have said they are hesitant to act.

"It's a very high bar," Atlanta Federal Reserve Bank President Dennis Lockhart told CNBC on Friday.

The March earthquake in Japan severely disrupted U.S. auto output, which subtracted 0.12 percentage point from GDP growth in the second quarter.

The decline combined with high gasoline prices to weigh on retail sales as consumers were unable to find the vehicle models they wanted.

Future spending strength will depend on employment and confidence. So far, the immediate outlook is not promising.

The Thomson Reuters/University of Michigan's index of consumer sentiment fell to 63.7 in July from 71.5 in June, a separate report showed.

But economists are cautiously optimistic the jobs market will have started to improve somewhat in July after faltering badly in the last two months, although U.S. companies are still trying to hold the line on hiring to save costs.

Merck & Co said on Friday that it plans to slash thousands of jobs by late 2015 to wring out savings of up to $1.5 billion a year.

Nonfarm jobs likely rose 90,000 in July, according to a Reuters survey, after June's paltry 18,000 gain.
Growth in the second quarter was supported by a smaller trade deficit, a pick-up in home building and a healthy rise in business spending. Most encouraging was a lack of a big build-up in business inventories, which rose only modestly.

"Inventory building does not seem to be overdone, which sets us up for a good boost from manufacturing in the second half," said Moody's Analytics' Sweet.

Government spending was another drag on growth in the second quarter. Overall inflation slowed during the quarter, but underlying price pressures continued to build.

(Editing by Leslie Adler)

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US QE3 sparks concerns !

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Possible US QE3 sparks concerns

By Hu Yuanyuan and Chen Ji 

BEIJING - The Federal Reserve said on Wednesday it could ease monetary policy further if the United States failed to see solid growth, which analysts said may add to China's inflation and endanger its $3.2 trillion foreign exchange reserves.

"The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support," Ben Bernanke, Fed chairman, told the House of Representatives Financial Services Committee. His remarks were generally interpreted as a signal of a possible QE3 (quantitative easing).

In late 2009, the Fed launched an unprecedented bond-buying drive to boost the economy and make credit more available, spending some $1.7 trillion on mortgage-backed securities and Treasuries before it ended in March 2010. It then initiated a second round of easing, that wrapped up in June, in which $600 billion of bonds were bought.

But the US economy remains weak, prompting the possible launch of a QE3. A Reuters/Ipsos poll released on Wednesday showed that the number of Americans who believe the country is on the wrong economic track rose to 63 percent this month, up from 60 percent in June. The country's jobless rate rose to 9.2 percent in June from 9.1 percent in May.



"If the Fed continues to print more money (as Bernanke hinted), it will drag China into a protracted war to limit liquidity and tame inflation," Lu Zhengwei, chief economist with Industrial Bank Co Ltd, said.

China's consumer inflation already surged to a three-year high of 6.4 percent in June, according to the National Bureau of Statistics. This was partly attributable to quantitative easing measures by the US, which drove global capital into the more lucrative developing markets, including China, analysts agreed.

Moreover, the potential injection of money in the US is likely to raise global commodity prices. Crude-oil futures finished higher on Wednesday boosted by Bernanke's comments. The rising prices may force emerging economies, such as China, Brazil and India, to pay more for imported commodities, further exacerbating their inflationary problems.

"It will be a very bad news for emerging countries," Lu said.

Those countries may have to continually tighten their monetary stance, such as by raising interest rates, further incurring capital inflows, Lu said.

Cao Fengqi, director of the Research Center for Finance and Securities at Peking University, told China Daily that a QE3 would lead to faster appreciation of the yuan against the dollar.

According to Cao, if the easing policy became a reality, the resulting flood of US dollars means a faster depreciation of the greenback, which threatens the security of China's foreign exchange stockpile as it will reduce the real value of the dollar-denominated reserves.

"The primary task for China is to control consumer prices and maintain steady and fast economic growth (to counter any external shocks)," Cao said.

The Foreign Ministry said on Thursday that it hoped the US government would take a responsible attitude to protect investor interests.

Bernanke's hint of a QE3 could also be a strategy to pressure lawmakers to agree on raising the US debt ceiling, analysts said.

US President Barack Obama and the Republicans are bogged down in negotiations to raise the borrowing limit before the Aug 2 deadline.

Bernanke may be "talking up the market" and goading Congress to reach a consensus on the ceiling, Chen Xingdong, chief economist with BNP Paribas Asia Ltd, said.

Moody's Investors Service on Wednesday put its AAA rating on US government bonds on watch for a possible downgrade, citing the "rising possibility that the statutory debt limit will not be raised on a timely basis", which would lead to a default on US Treasury debt obligations.

Meanwhile, Chinese rating agency Dagong Global Ratings Co Ltd on Thursday put US ratings on domestic and foreign currencies on a negative watch list because of the country's rising debt.

Dagong said the current political and economic situation had squeezed out room for tax increases, while it is difficult to curtail military and welfare spending.

In the worst-case scenario, the US public debt will continue to grow to 124 percent of the country's GDP in 2015, and the federal government will have to raise the debt limit by $5.5 trillion, Dagong said.

Dagong downgraded US ratings from AA to A+ on Nov 9, 2010 after the US government announced the second round of quantitative easing.

Wei Tian contributed to this story.

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Stupid central banker tricks

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By Paul R. La Monica

The euro has rallied against the dollar despite worries about Greece as investors bet on ECB rate hikes. Click chart for more on currencies.

NEW YORK (CNNMoney) -- Greek debt crisis? What Greek debt crisis?

The European Central Bank is meeting this Thursday and is widely expected to raise interest rates by a quarter of a percentage point to 1.5%. That would be the second rate hike by the ECB this year.

Sure, the austerity vote in Greece is good news since it could mean the worst-case scenario fears about a euro meltdown may not be realized.

But this isn't the end to the difficulties in Greece. Doesn't it seem just a bit odd that the ECB is contemplating more tightening at a time when there are still legitimate worries about the problems spreading to Portugal, Ireland, Italy and Spain? Moody's downgraded Portugal's debt to junk status on Tuesday.

The sovereign debt woes could be disastrous news for banks in France and Germany -- the two big euro zone nations that actually have somewhat healthy economies.

But the ECB, unlike the Federal Reserve in the U.S., only has one mandate: inflation. (The Fed is charged with watching prices as well as employment.)

And even though commodity prices have come back from their peaks earlier this year, they are still somewhat alarmingly high. Crude oil, for example, has crept back above $95 a barrel. So that may be all that ECB president Jean-Claude Trichet needs to justify bumping rates up a bit.

Still, will the move backfire?

Another ECB rate hike would further widen the gap between interest rates in the euro zone and here in the United States. (They've been near zero since December 2008.) The general rule of thumb in the land of paper money is that the higher the interest rates are, the stronger the currency.

Europe cited as scariest risk to economy

But that's a problem from an inflation standpoint. With oil and many other commodities denominated in dollars, the weaker the greenback gets, the more likely it is for commodity prices to go higher.

"An ECB rate hike means a higher euro going forward," said Brian Gendreau, market strategist with Financial Network Investment Corp., a Segunda, Calif.-based advisory firm.

"It seems paradoxical that Europe, with its very serious problems, has a currency that's strong and rising but that's a reality. That means the trading bias is in favor of a lower dollar and higher oil prices," Gendreau added.

It makes you wonder if David Letterman needs to expand his stupid tricks franchise and create one specifically for central bankers.

Other currency experts wondered if the ECB should just leave well enough alone since crude prices have pulled back in the past few months after surging due to Arab Spring-inspired supply disruption fears.



"I don't think the ECB would be doing the right thing with a rate hike. Oil prices are high but inflation pressures have abated quite a bit," said Kathy Lien, director of currency research for foreign exchange brokerage GFT in Jersey City.

Lien said the ECB needs to pay more attention to slow growth in Europe -- even if it's not officially one of that central bank's particular mandates.

"Price stability is the top priority but the more important question is should the ECB be doing this during a fragile point of negotiations with Greece?" she said. "Raising rates makes financing more difficult for people in Europe."

What makes matters more vexing is the fact that it's not as if the ECB won't have other opportunities to raise rates soon if inflation does in fact pick up.

The ECB will meet again on August 4 and has another meeting scheduled for September 8. Wouldn't it be more judicious to wait for at least another month or two to see how the situation in Greece plays out before rushing to raise rates again?



"I am a little puzzled by why the ECB seems so intent on raising interest rates right now. It's not going to ease any of the problems in the peripheral euro countries," Gendreau said.

Still, some think that the ECB rate hike may be a non-event. That's because the euro has already rallied against the dollar this year despite all the negative headlines about Greece, Portugal, Ireland, etc.

"The speculation about a rate hike has been in the cards for a couple of months," said Ian Naismith, co-manager of The Currency Strategies Fund (FOREX), a Sarasota-Fla. Based mutual fund specializing in foreign exchange investments.

Naismith pointed out that just because the ECB is likely to raise rates on Thursday does not mean that this is the beginning of a long cycle of rate hikes. The key is going to be whether Trichet signals that he's still worried about inflation and that more rate increases are on the way.

"Nothing is etched in stone," Naismith said.

Let's hope so. The ECB does seem strangely hell bent on rate hikes even though Europe is still in the midst of major financial upheaval.

But the last thing Greece, other troubled European nations and the rest of the world for that matter, need is for the ECB to make matters worse with ill-timed policy decisions.

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The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.