U.S. Economy Grows Faster Than Expected in Q2, Inflation Pressures Easing

The U.S. economy expanded faster than anticipated in the second quarter, with a 2.8% annualized growth rate driven by robust consumer spending and business investment. Inflation pressures eased, supporting expectations for a potential Federal Reserve interest rate cut in September.

U.S. Economy Surpasses Expectations with 2.8% Q2 Growth, Easing Inflation Bolsters Fed Rate Cut Hopes

The U.S. economy experienced a faster-than-anticipated expansion in the second quarter, with robust consumer spending and business investment increases. However, inflation pressures abated, preserving the expectation of a September interest rate cut from the Federal Reserve.

The Commerce Department's advance report on second-quarter gross domestic product, released on July 25, indicated that inventory building and increased government expenditure also contributed to growth in the previous quarter. Nevertheless, the housing market recovery experienced a slight decline and negatively impacted the economy. The trade deficit increased, which hurt GDP growth.

The report eased apprehensions that the economic expansion was on the brink of an abrupt conclusion, exacerbated by a subpar performance in the first quarter and April.

The labor market's resilience has enabled the economy to continue outperforming its global counterparts despite the substantial rate hikes implemented by the U.S. central bank in 2022 and 2023.

"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."

The Commerce Department's Bureau of Economic Analysis published an advance estimate of second-quarter GDP that indicated a 2.8% annualized increase in gross domestic product last quarter. This was twice the growth rate of 1.4% observed in the first quarter.

The GDP growth rate that economists polled by Reuters anticipated was 2.0%. Estimates varied from a 1.1% rate to a 3.4% tempo.

The growth rate in the year's first half was an average of 2.1%, which is half the 4.2% pace achieved in the last six months of 2023. That is slightly higher than the 1.8% rate that U.S. central bank officials consider the non-inflationary growth rate.

The economy's consumer expenditure, comprising over two-thirds of the total, expanded at approximately 2.3%, following a decline to 1.5% in the January-March quarter. Increased expenditures on healthcare, lodging, utilities, club memberships, visits to sports centers, parks, theaters, and museums, as well as gambling, were the primary factors driving spending.

Consumers also increased their expenditures on goods, such as new light trucks, recreational goods, and vehicles, furnishings, durable domestic equipment, and energy products.

Wage increases partially subsidized expenditures. The Labor Department's report on July 25 indicated that the labor market was gradually improving, as initial claims for state unemployment benefits decreased by 10,000 to a seasonally adjusted 235,000 for the week ending July 20.

Business investment increased as expenditure on equipment, primarily aircraft, increased at an 11.6% rate, following a 1.6% increase in the first quarter. Spending on intellectual property products continued to grow, albeit slower than the rapid pace observed during the January-March quarter.

In addition, businesses increased their inventory to $71.3 billion, up from $28.6 billion in the previous quarter.

After being a detriment to GDP growth for two consecutive quarters, inventories contributed 0.82 percentage points. This exceeded the 0.72 percentage point impact of a broader trade gap.

Robust Q2 Growth Driven by Strong Domestic Demand, Productivity Gains, and Easing Inflation Pressures

Growth was robust in the previous quarter despite excluding inventories, trade, and government expenditure. Domestic demand increased at a rate of 2.6%. The increase in final sales to private domestic purchasers was consistent with the rise 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.

Wall Street's stocks needed to be more consistent. The dollar declined about a basket of currencies, and the prices of U.S. Treasury securities increased.

The increase in GDP growth indicates a potential increase in productivity, which would ultimately reduce the rate of increase in labor costs and price pressures. The personal consumption expenditures (PCE) price index, excluding volatile food and energy components, increased at 2.9% after experiencing a 3.7% surge in the first quarter.

The rate of increase in the core PCE price index was slightly higher than the 2.7% predicted by economists; however, the trend is diminishing. In anticipation of their two-day policy meeting next week, policymakers will be pleased to learn that core inflation has increased by 2.7% from the previous year.

The Federal Reserve monitors the core PCE price index as one of the inflation measures for its 2% inflation objective.

"We think revisions to past [monthly] data may explain part of the miss," said Daniel Vernazza, chief international economist at UniCredit Bank.

After experiencing a 3.1% increase in the January-March quarter, the gross domestic purchases price index, the government's most comprehensive measure of economic prices, increased at 2.3%.

The Federal Reserve has maintained its benchmark overnight interest rate within the present range of 5.25%-5.50% for the past year. Since 2022, it has increased its policy rate by 525 basis points. Beginning in September, financial markets anticipate three rate reductions this year.

Despite the robust economic growth rate, the year's second half is still being determined. The labor market is experiencing a contraction, which will affect wage increases.

Although wages increased, the income available to households after accounting for inflation and taxes increased at a slower pace last quarter, increasing at a rate of 1.0%, compared to a 1.3% increase in the first quarter.

As a result, consumers utilized their savings and reduced their savings in the previous quarter to finance their expenditures. In the January-March period, the saving rate decreased from 3.8% to 3.5%, and it is currently significantly lower than its pre-pandemic average.

Additionally, economists predict that most of the Federal Reserve's rate hikes have yet to be observed. Additionally, revenues from state and local governments are declining, which may result in reduced expenditures. There are also concerns regarding the potential for new tariffs to result in businesses front-loading imports if former President Donald Trump is reelected to the White House in the upcoming presidential election in November.

However, a recession is not anticipated this year, as monetary policy is expected to be relaxed.

"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.