Surprisingly anemic economic growth could derail Fed rate hike and boost Trump campaign

The weak start to 2016 spilled into the spring, with the U.S. economy growing at a surprisingly anemic 1.2% annual rate in the second quarter, the Commerce Department said Friday.

The first of three estimates for the April-June period was less than half the pace of growth that economists had forecast, driven by the first decline in business inventories since 2011.

The economy’s performance could cause Federal Reserve policymakers to hold off on another interest rate hike until at least December.

”Second-quarter growth came in well below expectations and provides more evidence that the economy has weakened so far this year,” said Brian Schaitkin, senior economist at the Conference Board business group.

He predicted the latest data mean “a rate hike before the end of the year is unlikely unless growth strengthens considerably in the coming months.

A third-straight quarter of anemic growth also could affect the presidential race, reinforcing Republican nominee Donald Trump’s criticism of the Democrats’ handling of the economy.

“I think the number made the economy look weaker than it really is, but it reinforces a narrative that we’re stuck in a mediocre growth pattern, and that hardly helps” Democratic nominee Hillary Clinton, said Greg Valliere, chief global strategist at Horizon Investments.

Stephen Miller, a senior policy advisor to Trump, called the growth report “catastrophic.”

After the poor first half of 2016, economic growth this year is likely to tumble below 2% this year. That would be down from the 2.6% growth last year and below the sluggish pace that has marked the recovery from the Great Recession.

Jason Schenker, president of Prestige Economics, said Friday’s report “confirms our expectations of a coming recession.”

But other economists pointed to strong consumer spending in the second quarter as a reason for optimism. The 4.2% annual rate of growth — the best since 2014 — should lead businesses to replenish their inventories.

“The U.S. economy -- specifically the U.S. consumer — is one of the bright spot of the whole global economy,” Nariman Behravesh, chief economist at IHS Markit.

Still, the numbers this year have been disappointing.

The Commerce Department on Friday also revised down first-quarter growth to just a 0.8% annual rate — the worst in two years — from an estimate last month of 1.1%. The fourth quarter wasn’t much better, revised down to 0.9% from an earlier estimate of 1.4%.

Experts had expected the U.S. economy to bounce back strongly in the second quarter after the pace of growth slowed sharply over the winter, partly because of financial market turmoil.

But the economy continued to struggle to gain traction.

Although consumers boosted their rate of spending significantly from the first quarter’s 1.6% pace, business and government investment fell off.

Business investment declined at a 9.7% annual rate in the second quarter, much worse than the 3.3% drop-off in the previous quarter. A key component was investment in housing, which declined at a 6.1% annual pace after increasing at a 7.8% annual rate in the first quarter.

Government investment declined at a 0.9% pace in the second quarter after increasing at a 1.6% pace the previous quarter. The biggest drop-offs were in federal defense spending and investments by state and local governments.

The decline in inventories was the biggest surprise. They fell by $8.1 billion -- the fifth straight decline — after increasing by $40.7 billion in the first quarter, the Commerce Department said.

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The drop in inventories reduced the annual rate of growth in the second quarter by nearly 1.2 percentage points.

Jason Furman, chairman of the White House Council of Economic Advisers, said that inventory investment was one of the most volatile components of economic growth.

”The level of inventory investment in the second quarter was negative, which is not sustainable over time and suggests inventory investment will likely make a positive contribution to growth at some point in the coming quarters,” he said.

Behravesh expects that bounce-back to start this summer.

“Businesses have been trying to reduce the number of goods piling up on their shelves,” he said. “They accomplished this with a vengeance in the second quarter.”

“That’s not going to happen again in the third quarter,” Behravesh said.

He expects growth of 2% to 2.5% in the second half of the year.

But that still would mean growth this year would be just 1.5%, Behravesh said. It would be the worst performance since the Great Recession ended in 2009.

In their most recent forecast, in June, Fed officials predicted the economy would expand 2% this year.

And on Wednesday, central bank policymakers said the economy appeared to be “expanding at a moderate rate.” They indicated that their concerns had eased about a slowing labor market and fallout from the British vote to leave the European Union.

Job growth had rebounded strongly in June to 287,000 after the economy added just 11,000 net new positions in May.

Those upbeat comments had opened the door to an increase in the central bank’s benchmark short-term interest rate as early as September.

The Commerce Department will revise the second-quarter figure two more times before the Fed meets.

Now economists will be watching next Friday’s jobs report closely to see if the labor market retained its strength in July, another key factor in the Fed’s deliberations.

Economists expect that the nation added a solid 175,000 net new jobs last month. The unemployment rate is forecast to tick down to 4.8%.

UPDATES:

2:35 p.m.: This article was updated with comment from a Trump campaign advisor.

10:30 a.m.: This article was updated with additional data.

12:43 p.m.: This article was updated with additional analysis.

2:55: This article was updated with a quote from the Trump campaign.

The article was originally published at 6:20 a.m.