GDP Rises An Anemic 0.7 Percent Friday July 27, 6:09 PM EDT

By Caren Bohan

WASHINGTON (Reuters) - The U.S. economy turned in its weakest performance in eight years in the second quarter, as businesses slashed spending on software and new equipment and pared inventories, the government said on Friday.

But there was a bright spot in the Commerce Department's report of a meager 0.7 percent annual-rate gain in gross domestic product: the economy managed to escape a contraction in GDP and so is unlikely to have fallen into a recession.

"The GDP number is a little bit weaker than expected but it's still positive," said Stuart Hoffman, chief economist at PNC Financial Services Group in Pittsburgh. "The recession bells are not ringing."

The bleakest element of the data was business spending, which sank 13.6 percent in the April-to-June quarter. But the consumer, government and home-building sectors all contributed to growth, helping to keep GDP in the plus column.

The GDP figure was lower than the 0.9 percent gain forecast by U.S. economists in a Reuters survey. Its weakness cemented expectations for a seventh cut in short-term interest rates by the Federal Reserve at its next meeting on Aug. 21.

A GREEN LIGHT FOR FED?

Those expectations pushed bond prices higher, but the lackluster economic data put a damper on the prices of blue-chip stocks.

"For the bond market, it's a plus. For the Fed, it means a green light to ease 25 basis points in August," Astrid Adolfson, economist at MCM Moneywatch in New York.

The Dow Jones industrial average fell 39 points to 10,417. But the Nasdaq composite index edged up 7 points to 2,030.

Speaking at the White House to student leaders of the Future Farmers of America, President Bush said: "The economy is puttering along. It is not nearly as strong as it should be."

His chief economic adviser, Lawrence Lindsey, thought the data showed the worst might be over.

"We have seen the worst of times already," he told CNN. "I think the second quarter is going to be the worst quarter we'll have experienced and we'll have dodged a major bullet."

Growth in GDP, the broadest measure of the nation's economic health, has been slow for the past year. In recent months, some economists had begun to fear it might actually decline in the second quarter.

That would have been an ominous sign, since a recession -- something the country has not seen since 1990-91 -- is loosely defined as at least two straight quarters of falling GDP.

Second-quarter GDP marked a weakening from the first three months of the year, when GDP rose 1.3 percent, a number that was revised up from the originally reported 1.2 percent rise.

U.S. consumers, whose spending makes up two-thirds of GDP, curbed their purchases in the second quarter but remained the economic stalwarts. Their expenditures increased at a 2.1 percent rate in the second quarter following a 3 percent gain in the first three months of the year.

But businesses have hit hard times, as weaker demand has cut sharply into their profit margins.

Since the beginning of the year, companies have been reducing inventories to bring supplies of unsold cars, computers and other goods back into line with demand.

That process continued in the second quarter, with inventories falling $26.9 billion after a $27.1 billion decline in the first quarter. However, inventories made a fractionally positive contribution to growth, since the latest inventory drop was milder than the first-quarter decline.

The 13.6 percent nosedive in business investment spending in the second-quarter, however, was the biggest drop in 19 years.

HOUSING AN ANCHOR OF STRENGTH

Strength in home building helped to offset business weakness. Investment in new residences climbed 7.4 percent.

More upbeat data on the housing sector rolled in on Friday as the Commerce Department, in a separate report, said sales of new U.S. single-family homes rose 1.7 percent in June to 922,000. That beat analysts' expectations of 921,000.

Also released on Friday was a fresh reading on consumer confidence that showed a slight decline in sentiment.

The University of Michigan's July consumer sentiment index fell to 92.4 from 92.6 in June.

Within the GDP report, tame inflation emerged as one of the silver linings.

The price index for personal consumption expenditures rose a mild 1.7 percent, the smallest gain since the first quarter of 1999. The index, closely watched by the Federal Reserve, increased 3.2 percent in the first quarter of this year.

The latest GDP release included some methodology changes, including a key change to the way telecommunications equipment is treated, and updated data from recent business surveys.

The changes showed the economy slowed more than previously thought in the second half of last year.

The Bush administration seized on the revision to make the case that the economy began losing steam under former President Bill Clinton.

"There should be no mistake about when the softness in the economy actually began," White House spokesman Ari Fleischer told reporters. "It is a simple matter of economic record that the slowdown began in the summer of 2000 and it endures today."

GDP grew 1.3 percent in the third quarter of last year, revised down from the previously reported 2.2 percent gain. Fourth-quarter growth was revised upward, however, to 1.9 percent from a 1.0 percent rise.

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-- Martin Thompson (mthom1927@aol.com), July 27, 2001