Economy slows sharply as inflation heats up

updated 10:18 a.m. ET July 28, 2006

WASHINGTON - The economy’s growth slowed sharply in the second quarter, logging just a 2.5 percent pace as consumers tightened their belts and spending on home building nose-dived. Inflation, however, shot up.

The latest snapshot of gross domestic product released by the Commerce Department on Friday showed that the overall pace of economic activity in the April-to-June quarter was less than half that of the January-to-March quarter, when the economy zipped along at a 5.6 percent annual rate, the fastest in 2 1/2 years.

Gross domestic product measures the value of all goods and services produced within the United States and is considered the best barometer of the country’s economic standing.

“The economy has significantly throttled back but inflation pressures are developing more fully,” observed Mark Zandi, chief economist at Moody’s Economy.com

The second-quarter’s performance — which reflected the bite of high energy prices and rising interest rates on people and businesses as well as a cooling in the once red-hot housing market — was weaker than the 3 percent pace analysts were forecasting.

The 2.5 percent pace was the slowest since a 1.8 percent growth rate in final quarter of 2005, when the economy was suffering fallout from the devastating Gulf Coast hurricanes.

Even though the economy cooled in the second quarter, inflation heated up.

An inflation gauge closely watched by the Federal Reserve showed that core prices — excluding food and energy — jumped at a 2.9 percent annual rate in the second quarter — far outside the Fed’s comfort zone. That was up from a 2.1 percent growth rate in the first quarter and marked the highest inflation reading since the third quarter of 1994, when core inflation rose at a 3.2 percent pace.

The inflation reading was taken before the latest run-up in energy prices. Oil prices hit a record closing high of $77.03 a barrel on July 14. Gasoline prices also have marched higher, topping $3 a gallon in many areas.

In a separate report from the Labor Department, employers’ costs to hire and retain workers picked up in the second quarter, a development that also could raise some inflation concerns.

Compensation costs — including wages and benefits — rose by 0.9 percent in the April-to-June period, up from a 0.6 percent increase in the first quarter. Economists were calling for a 0.8 percent rise.

Although Federal Reserve Chairman Ben Bernanke said he is concerned about rising inflation, he told Congress last week that the Fed believes moderating economic activity will eventually lessen inflation pressures.

That assessment raised hopes on Wall Street that the Fed might take a breather in its two-year-old rate-raising campaign at its next meeting, on Aug. 8. Some economists, however, continue to predict that rates will be bumped up again at the August meeting to ward off inflation; after that, they think the Fed may move to the sidelines.

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