Putting on the brakes

WASHINGTON - The economy expanded at a meager 1.3 percent annual rate in the spring after scarcely growing at all in the first three months of the year, the Commerce Department said Friday.

The combined growth for the first six months of the year was the weakest since the recession ended two years ago. The government revised the January-March figures to show just 0.4 percent growth, down sharply from its previous estimate of 1.9 percent.

The data was much worse than economists expected and caused many of them to lower their growth forecasts for the rest of this year.

"This is not a death sentence for the recovery, but it does raise some concerns," said Carl Riccadonna, an economist at Deutsche Bank. He said the current level of growth is too weak to keep the unemployment rate from rising.

High gas prices and scant income gains have forced Americans to pull back sharply on spending. Consumer spending only increased 0.1 percent in the April-June quarter, the smallest gain in two years. Government spending fell for the third straight quarter.

Stocks dropped in early trading, then regained some lost ground. The Dow Jones industrial average fell 56 points, and broader indexes also declined.

The sharp slowdown means the economy will likely grow this year at a weaker pace than last year, when it expanded by 3 percent.

Nariman Behravesh, chief economist at IHS, said the economy will likely expand less than 2 percent in the July-September period. That's down from the firm's previous estimate of at least 2.5 percent.

The weaker data will also add pressure to already-tense negotiations between President Barack Obama and lawmakers over increasing the debt limit. Any deal will likely include deep cuts in government spending. That could slow growth further in the short term.

But if Congress fails to raise the debt limit and the government defaults, financial markets could fall and interest rates could rise.

Obama cited the dismal growth figures Friday as a reason for lawmakers to reach a solution.

"On a day when we've been reminded how fragile the economy is, this is a burden we can lift ourselves," Obama said.

Economists have said the negotiations have injected a large amount of uncertainty into the frail recovery. Some businesses are holding back on hiring and expansion plans.

"It is hard to see the economy getting much stronger," Paul Dales, an economist at Capital Economics, said in a research note. "In fact, if the debt ceiling is not raised ... we could well have another recession on our hands."

A rebound in the second half of the year will also depend on consumers, who fuel 70 percent of economic growth.

Consumer spending on long-lasting manufactured goods, such as cars and appliances, fell 4.4 percent in the second quarter. Many auto dealers reported shortages of popular models after Japan's March 11 earthquake disrupted supply chains. That cut into auto sales.

Auto sales and production are likely to rebound in the July-September period as supply disruptions ease, economists said. That should boost growth.

Overseas sales may also give the economy a lift in the second half of the year. Exports rose 6 percent in the April-June quarter. Large U.S. exporters are benefiting from a weaker dollar and stronger growth in foreign markets, a trend economists expect to continue.

Still, economists don't expect growth to pick up enough in the second half of the year to lower the unemployment rate, which rose to 9.2 percent last month.

The economy typically needs to grow by 5 percent for a full year to reduce the unemployment rate by a full percentage point. Growth of 3 percent is generally enough to keep up with population changes.

Earlier this year, economists were optimistic that a Social Security payroll tax cut would accelerate growth and help strengthen the recovery. Instead, most of that money - roughly $1,000 to $2,000 per person - has gone to pay for higher gas prices.

The average price for a gallon of gas peaked in early May at nearly $4. While it has eased since then, motorists paid an average of $3.71 per gallon on Friday - nearly a dollar more than they paid a year ago.

Employers have pulled back on hiring after seeing less spending by consumers. The economy added just 18,000 net jobs in June, the fewest in nine months and a steep drop from the average of 215,000 jobs per month added from February through April.

Those who have jobs are seeing little gain in their incomes. After-tax incomes, adjusted for inflation, rose only 0.7 percent, matching the previous quarter and the weakest since the recession ended.

The drop in government spending was driven by cuts at the state and local level. Those governments have slashed spending in seven of the eight quarters since the official end of the recession.

State and local government spending accounts for roughly 12 percent of the economy. The recession and slow recovery has drastically reduced tax revenues. That has forced many governments to lay off workers and rein in spending.

In the past two years, state and local governments have cut more than a half-million jobs. In most recoveries, governments add jobs and support growth.

Business investment, which has been a driver of growth during the recovery, also faltered this spring. Spending on equipment and software grew 5.7 percent in the second quarter, down from the first quarter's 8.7 percent pace and below the double-digit gains posted last year.

The government also revised data going back to 2003. The revisions show the recession was even worse than previously thought. The economy shrank 5.1 percent during the recession, which lasted from December 2007 through June 2009, compared to the earlier estimate of 4.1 percent. Both figures represent the worst downturn since World War II.

The government now says the economy is smaller than it was before the recession. Prior to the revisions, the government had said production of goods and services surpassed the pre-recession level in 2010.

"The depth of the recession is now clearly so much deeper," said Nigel Gault, an economist at IHS.

The government revises its data on the economy annually, using a variety of updated information from the Census Bureau, Internal Revenue Service, and Labor Department.

Friday's report is the first of three estimates the government releases of the gross domestic product, which measures everything from restaurant meals to auto production to government spending.