updated 8/27/2004 2:09:56 PM ET 2004-08-27T18:09:56

The U.S. economy, struggling under the weight of a bloated trade deficit, grew at a relatively modest 2.8 percent annual rate in the second quarter, a slower pace of expansion than previously thought.

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The new reading on gross domestic product (GDP) issued by the Commerce Department Friday furnished fresh evidence that the business recovery hit a rut in the spring and early summer. The growth rate was weaker than the 3 percent figure first estimated a month ago and showed that the economy, which had been moving along at a decent clip, lost considerable momentum in the April-to-June quarter.

The economy had grown at a brisk 4.5 percent pace in the first three months of 2004. Gross domestic product measures the value of all goods and services produced within the United States and is considered the broadest barometer of the economy’s fitness.

The revised GDP figure for the second quarter, however, is slightly better than the 2.7 percent growth rate that some economists had forecast. “Economic growth was below par — temporarily we think — but the expansion is still continuing,” said Lynn Reaser, chief economist at Banc of America Capital Management.

The latest snapshot of the economic activity comes as President Bush gets geared up for the Republican convention, and the presidential election is just over two months away.

The economy’s health and the availability of jobs have been key sparring issues between Bush and his Democratic opponent, John Kerry.

Bush says that making his tax cuts permanent will strengthen the economy and spur more job growth. Kerry, pointing to the sluggish labor market and the loss of 1.1 million jobs since Bush took office, says the president’s tax cuts have mainly helped the wealthy and squeezed the middle class.

Federal Reserve Chairman Alan Greenspan has described the economy as hitting a “soft patch” in June. Even so, the Fed policy-makers on Aug. 10 raised short-term interest rates for the second time this year in a bid to keep future inflation under control. The Fed’s most recent rate move pushed a key interest rate to 1.50 percent. Fed policy-makers at the time expressed confidence that economic activity would gain momentum in the months ahead.

Some private economists estimate that economic growth in the current July-to-September quarter could come in at around a 3.5 percent to 3.8 percent annual rate. Many believe the Fed will raise rates again at its Sept. 21 meeting.

Greenspan, in a speech Friday, didn’t address the future course of interest rates. But he warned that the country will face “abrupt and painful” choices if Congress does not move quickly to trim the Social Security and Medicare benefits that have been promised to the baby boom generation.

Kerry’s campaign said in a statement that the new GDP figures provide evidence that “George Bush is misleading Americans when he says that the economy has turned a corner.” Treasury Secretary John Snow said: “Our economy is once again on solid footing.” But he added, “There is still more work to do.”

Soaring energy prices, meanwhile, have taken a toll on economic activity — aggravating the U.S. trade deficit as the nation’s foreign oil bill swelled and also putting a damper on consumers’ willingness to spend. Oil prices, which recently have climbed to all-time highs on U.S. markets, have been moderating in recent days.

The country’s swollen trade deficit in the second quarter shaved 1.37 percentage points off GDP, compared with a 0.76 percentage point reduction in the prior quarter. The second-quarter trade situation was worse than first thought — the biggest factor in the downward revision to second quarter GDP.

Consumers, whose spending accounts for roughly two-thirds of all economic activity, had a tight grips on their pocketbooks and wallets in the spring, a key factor behind the second-quarter’s overall slowdown. Consumer spending increased at an annual rate of 1.6 percent, the slowest pace since the second quarter of 2001, and down from a brisk 4.1 percent growth rate in the first quarter of this year.

The new estimate of consumer spending for the second quarter, however, marked a slight improvement from the 1 percent growth rate first estimated. Spending on big-ticket goods, such as cars and appliances, was flat in the second quarter, compared with a decline previously reported.

Business spending on equipment and software, meanwhile, grew at a sizable 13.6 percent annual rate in the second quarter, better than previously estimated and up from an 8 percent growth rate in the first quarter.

One measure of after-tax profits contained in the GDP report showed that profits shrank by 1.2 percent in the second quarter from the previous quarter. But profits are up by 17.9 percent from a year ago.

An inflation gauge favored by Greenspan, which excludes energy and food prices, showed that inflation remained tame in the second quarter. The measure showed that prices rose at an annual rate of 1.7 percent in the second quarter, down from a 2.1 percent increase in the first quarter.

As long as inflation doesn’t become a problem, Greenspan has said the Fed can move interest rates up gradually.

The 2.8 percent growth rate for the overall economy in the second quarter was the smallest gain since the first quarter of 2003, when the economy expanded at a 1.9 percent pace.

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