Dark clouds on US economic horizon
 
The administration of President George W. Bush has remained relentlessly optimistic about the outlook for the US economy. Brushing off the recent spate of weak data by arguing that a similar slowdown at the same time last year was followed by a strong resurgence, Carlos Gutierrez, the commerce secretary, told reporters on Monday that there was “a very healthy momentum to the economy”.

But what initially seemed to be a short-lived “soft patch” much like the blip in growth last spring is now looking a little more ominous.

Data released on Monday showed that manufacturing activity slowed further in April, with the Institute for Supply Management index sliding more steeply than expected from 55.2 to 53.3.

The index has fallen in eight of the nine previous releases and is creeping perilously close to the 50 mark that separates expansion from contraction. Particularly worrying was a sharp fall in the new orders component of the index to 53.7 from 57.1, which may point to weaker production in coming months.

The figures continued a pattern of fairly gloomy economic releases last month.

Both the Federal Reserve and private sector economists have long been braced for a slowdown in consumer spending. Even so, evidence of an almost complete stagnation of retail sales in March which rose by just 0.1 per cent, excluding the volatile auto sector came as an unwelcome surprise.

The main concern, however, has been evidence of a slowdown in business investment. This grew by 10.6 per cent last year and was expected to continue to push the economy forward as consumers reined back their spending.

Last week's gross domestic product figures showed the growth in overall business investment slowing to 4.7 per cent in the first quarter, from 14.5 per cent in the previous three months.

Perhaps more worrying, there was evidence in the durable goods orders figures that this weakness is spilling over into the second quarter. Orders for non-defence capital goods components, excluding aircraft a proxy for business investment fell 4.7 per cent in March following a 2.5 per cent decline a month earlier.

The basic problem appears to be that consumers have the willingness to spend more but increasingly lack the ability, while businesses have the money to step up spending but seem to lack the willingness.

Ian Morris, an analyst at HSBC and a long-term bear on the US economy, believes this latest soft patch is likely to be more serious than the bout of weakness last spring. “The difference is that last spring was a blip in an otherwise improving economy,” he says. “This time we are seeing a blip downwards in a slowing economy. Things may not continue to deteriorate so quickly but don't hold your breath for a vigorous bounce back either.”

Consumers and businesses may now face additional headwind over coming months.

On the corporate side, the slowdown in long-term investment is not the only worry. Some economists fear that companies may also be forced to pare back inventories in the second quarter, having overstocked in the first.

The GDP figures suggested that some businesses may have been caught offguard by the fall in demand in March. Partly as a result they added a massive $80.2bn (€61.7bn, £42.2bn) to inventories, $33bn more than in the previous quarter.

“This could come back to haunt us in the second quarter as companies reduce their orders,” says Paul Ashworth, an analyst at Capital Economics, the consultancy. Neither are consumers well placed to embark on a fresh spending spree, despite the continued strength in the housing market.

According to the government's employment cost index, wages grew by just 2.4 per cent in the first quarter against a year ago the slowest rate on record. With companies still in parsimonious mood and plenty of slack still left in the labourmarket, the scales arestill stacked in favour of employers in salary negotiations.

Finally the Federal Reserve, which is expected today to make the eighth in a series of quarter-point increases in short-term rates since last June, may find it hard to provide relief to the economy by slowing the pace of monetary tightening.

The central bank's favourite measure of inflation the core personal expenditure index rose 1.7 per cent in the year to March. This is close to the upper end of the Fed's forecast for 2005-06, giving little room for manoeuvre.
 


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