WASHINGTON, July 25 (Reuters) - The U.S. economy grew faster than expected in the second quarter amid solid gains in consumer spending and business investment, but inflation pressures subsided, leaving intact expectations of a September interest rate cut from the Federal Reserve.
Growth last quarter also received a boost from inventory building as well as increased government spending, the Commerce Department's advance report on second-quarter gross domestic product on Thursday showed. The housing market recovery, however, regressed and was a small drag on the economy. The trade deficit widened further, subtracting from GDP growth.
The report dispelled concerns that the economic expansion was in danger of an abrupt end, which had been stoked by a lackluster performance in the first quarter and in April.
The economy continues to outperform its global peers, despite hefty rate hikes from the U.S. central bank in 2022 and 2023, thanks to a resilient labor market.
"Economic growth is solid, not too hot and not too cold," said Christopher Rupkey, chief economist at FWDBONDS. "Inflation looks to be going the Fed's way and an easing of monetary restraint with an interest rate cut is likely in September."
Gross domestic product increased at a 2.8% annualized rate last quarter, the Commerce Department's Bureau of Economic Analysis said in its advance estimate of second-quarter GDP. That was double the 1.4% growth pace in the first quarter.
Economists polled by Reuters had forecast GDP rising at a 2.0% rate. Estimates ranged from a 1.1% rate to a 3.4% pace.
The growth rate in the first half of the year averaged 2.1%, half the 4.2% pace logged in the last six months of 2023. That is just above the 1.8% pace viewed by U.S. central bank officials as the non-inflationary growth rate.
Consumer spending, which accounts for more than two-thirds of the economy, increased at around a 2.3% rate after slowing to a 1.5% pace in the January-March quarter. Spending was driven by increased outlays on services like healthcare, housing and utilities as well as club memberships, visits to sports centers, parks, theaters and museums, and gambling.
Consumers also boosted outlays on goods, including new light trucks, recreational goods and vehicles, furnishings and durable household equipment as well as energy products.
Spending was in part supported by wage gains. A separate report from the Labor Department on Thursday showed the labor market steadily easing, with initial claims for state unemployment benefits dropping 10,000 to a seasonally adjusted 235,000 for the week ended July 20.
Business investment picked up as spending on equipment, mostly aircraft, surged at an 11.6% rate after rising at only a 1.6% pace in the first quarter. Spending on intellectual property products continued to rise, though the pace slowed from the brisk rate in the January-March quarter.
Businesses also accumulated more inventory, which increased at a $71.3 billion rate after rising at a $28.6 billion pace in the prior quarter.
Inventories added 0.82 percentage point to GDP growth after being a drag for two straight quarters. That more than offset a 0.72 percentage point hit from a wider trade gap.
STRONG DOMESTIC DEMAND
Even discounting inventories, trade and government spending, growth was solid last quarter, with domestic demand rising at a 2.6% pace. The increase in final sales to private domestic purchasers matched the gain in the January-March quarter.
"The U.S. economy is much stronger than people realize and to the extent that markets were worried about a growth slowdown, they should breathe a sigh of relief," said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.
Stocks on Wall Street were mixed. The dollar slipped against a basket of currencies. U.S. Treasury prices rose.
The rise in GDP growth bodes well for a pick-up in productivity, which would slow the pace of increase in labor costs and ultimately price pressures. The personal consumption expenditures (PCE) price index, excluding the volatile food and energy components, increased at a 2.9% rate after surging at a 3.7% pace in the first quarter.
While the rise in the so-called core PCE price index was slightly above economists' expectations for a 2.7% rate of increase, the trend is slowing. Core inflation increased 2.7% from a year ago, welcome news for policymakers ahead of their two-day policy meeting next week.
The core PCE price index is one of the inflation measures tracked by the Fed for its 2% target.
"We think revisions to past [monthly] data may explain part of the miss," said Daniel Vernazza, chief international economist at UniCredit Bank.
The government's broadest gauge of prices in the economy, the gross domestic purchases price index, rose at a 2.3% pace after jumping at a 3.1% rate in the January-March quarter.
The Fed has maintained its benchmark overnight interest rate in the current 5.25%-5.50% range for the past year. It has hiked its policy rate by 525 basis points since 2022. Financial markets expect three rate cuts this year, starting in September.
Despite the solid economic growth pace, the outlook for the second half of the year is hazy. The labor market is slowing, which will impact wage gains.
Though wages rose, income at the disposal of households after adjusting for inflation and taxes increased more slowly last quarter, rising at a 1.0% rate after climbing at a 1.3% pace in the first quarter.
That meant consumers turned to savings and also saved less to fund their spending last quarter. The saving rate fell to 3.5% from 3.8% in the January-March period and is now well below its pre-pandemic average.
Economists also estimate that much of the Fed's rate hikes is still to be felt. State and local government revenues are also slowing, which could erode spending. There are also worries about new tariffs, which could see businesses front-loading imports if former President Donald Trump is returned to the White House in November's presidential election.
Nonetheless, a recession is not expected, with monetary policy easing anticipated this year.
"Economic activity is indeed about to downshift into a below potential path in the second half of the year," said Scott Anderson, chief U.S. economist at BMO Capital Markets.
Reporting by Lucia Mutikani; Editing by Chizu Nomiyama and Andrea Ricci
