Growth may lead Fed to slow bond buys

WASHINGTON (AP) - A stronger-than-expected rise in U.S. economic growth last quarter will likely strengthen the hand of Federal Reserve officials who want to slow the Fed's bond purchases next month.

The economy grew at a 2.5 percent annual rate from April through June, the government estimated Thursday. That was more than twice the growth rate in the first quarter and far above an initial estimate of a 1.7 percent rate for April through June.

The Fed is weighing key measures of the economy's health before it meets Sept. 17-18 to decide whether to scale back its $85 billion in monthly bond purchases. The Fed's bond buying has helped keep long-term borrowing rates near record lows. A stronger economy would need less support from the Fed.

Global financial markets have been under pressure over speculation that the Fed will slow its purchases and send interest rates in the United States higher. U.S. rates have already been rising in anticipation of a pullback in Fed bond buying. But the Fed may decide the economy is strengthening enough to withstand higher rates.

Last quarter's faster growth "should give Fed officials more confidence that the recovery is gathering steam," said Paul Ashworth, chief U.S. economist at Capital Economics.

Other analysts think the Fed might decide to maintain the pace of its bond buying to help fuel the economy. They think Fed officials may conclude that the still-subpar U.S. economy could falter under the weight of higher interest rates, a slower housing rebound or a messy resolution to a fight over the federal budget.

Almost everyone agrees that the biggest factor the Fed will weigh in deciding whether to slow its bond buying will come next week: The employment data for August - the final jobs report before the Fed meets.

On Thursday, the government upgraded its estimate of growth for last quarter mainly because the U.S. trade deficit narrowed in June. That occurred because U.S. companies exported more goods than previously thought and imported fewer. The narrower trade gap offset weaker spending by the U.S. government.

For the second half of the year, analysts generally think the economy will grow at an annual rate of around 2.5 percent, fueled by steady job gains and a diminished impact from federal spending cuts.

That growth rate, though, would be too weak to meet the Fed's own forecasts for 2013. It might decide to delay any pullback in bond buying to await more data on how the economy is faring in the second half of the year.

James Marple, senior economist at TD Bank Group, noted that even with the government's higher estimate of second-quarter growth, the economy would have to accelerate at an annual rate of 2.8 percent to 3.4 percent in the second half to reach the Fed's growth forecast for 2013.

Doug Handler, chief U.S. economist at IHS Global Insight, noted: "We still have an economy that is not operating on all cylinders. And you have a variety of threats, ranging from rising interest rates to the tensions in the Middle East, that are causing anxiety for businesses and consumers."

Another challenge for the economy: The Obama administration and Congress are locked in a battle over funding the government. Treasury Secretary Jacob Lew has said the government will run out of money to pay its bills in mid-October unless lawmakers raise the federal borrowing cap, which is capped at $16.7 trillion.

In addition, expectations that the Fed will slow its bond buying have triggered problems in emerging nations. Anticipation of rising U.S. interest rates has led investors to pull money from many of those nations and invest it in higher-yielding U.S. assets.

On Thursday, for example, Indonesia's central bank raised its benchmark interest rate by half a percentage point in hopes of stemming a fall in its currency's value.

In light of the uncertainties, Handler said he expects the Fed to delay any reduction in its bond purchases until December.

Joel Naroff, chief economist at Naroff Economic Advisors, said he thinks the Fed will lower its forecast for 2013 growth when it meets in September. If so, Naroff said it would be awkward for the central bank to begin slowing its bond purchases while also reducing its growth forecast for the year.

Diane Swonk, chief economist at Mesirow Financial, said she still thinks September is the likely month for the Fed to start slowing its bond buying. But she said it's a close call.

Swonk noted that next week's jobs report for August will likely be decisive. Weaker-than-expected jobs data could give Fed officials who favor maintaining the pace of bond purchases the evidence they need, she said.

But the trend in job growth is giving economists hope for a solid number for August. Employers have added an average of 192,000 jobs a month so far this year.

And the government said Thursday that the number of Americans seeking unemployment benefits remains near the lowest level in more than five years. First-time applications fell 6,0000 last week to a seasonally adjusted 331,000. That means employers are cutting fewer and fewer jobs.

Thursday's report on economic growth for April through June showed that government spending shrank an annual rate of 0.9 percent, worse than the 0.4 percent drop initially estimated.

Two key areas of the economy - housing and business investment - remained strong. Housing construction grew at an annual rate of 12.9 percent in the April-June period, the fourth straight quarter of double-digit growth. Still, average mortgage rates have risen more than a full percentage point since May. Though they remain low by historical standards, the sudden spike in rates could slow the housing recovery's momentum.

Consumer spending, which accounts for 70 percent of economic activity, grew by a 1.8 percent annual rate last quarter. That was unchanged from the initial estimate. But it was down from a 2.3 percent annual growth rate in the first quarter.

A key signal of the economy's health in the second half of 2013 will come from Friday's report on consumer spending in July. Consumer spending held up in June. But rising interest rates might have caused it to slow in July.