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U.S. economy shrank less than previously estimated, easing recession fears

Are we in a recession?
MoneyWatch: The Uncertain Economy: Are we in a recession? 06:04

The U.S. economy shrank at a 0.6% annual rate from April through June, the government said Thursday — a slight upgrade from its initial estimate and a sign that this year's drop in growth is less steep than originally feared. 

Most economists have said they doubt the economy is in, or on the verge of, a recession, noting that hiring remains strong, with low unemployment and ample job openings. Still, inflation is near a four-decade high and is punishing consumers and businesses. And the Federal Reserve's concerted campaign to tame inflation by driving up interest rates is raising the risk of a "hard landing" for the economy. 

"Recent employment and consumption data all but indicate the economy is not in a recession," Lydia Boussour, lead U.S. economist at Oxford Economics, said in a report. "But a faltering housing market and souring economic sentiment are clear signs that elevated inflation and higher borrowing costs are taking a toll on the economy."

In its revised estimate Thursday, the Commerce Department calculated that the nation's gross domestic product — the broadest measure of economic output — contracted last quarter, though less than the 1.6% annual decline in the January-March period. In its previous estimate for the April-June quarter, the government had estimated that the economy had shrunk at a 0.9% rate.

Consumer spending, which accounts for nearly 70% of U.S. economic activity, grew last quarter, but at a slower 1.5% annual pace, down from 1.8% from January through March.

By contrast, government spending and business investment declined. And inventories tumbled as businesses slowed their restocking of shelves, shaving 1.8 percentage points from GDP.

Rising interest rates hammered the housing market. Home construction plunged 16.2%.

Mixed signals

Adding to the mixed economic signals is the first estimate of gross domestic income, another measure of economic growth. GDI expanded at a below-normal 1.4% pace in the second quarter, down from its 1.8% gain in the first. 

"The gap between the GDP and GDI figures has therefore continued to widen, with the two sets of figures telling completely different stories about the economy. GDP is 2.6% above pre-pandemic levels while GDI is 6.4% higher," Michael Pearce, senior U.S. economist at Capital Economics, said in a research note. "The gap between the two has never been wider."

The divergence makes it likely that the GDP figures will be revised "substantially higher" in later months, he added.

Fed not done hiking rates

In its drive to curb inflation, the Fed has raised its benchmark interest rate four times this year by increasingly large increments. By raising borrowing rates, the central bank is making it costlier to take out a mortgage or an auto or business loan. The idea is that consumers and businesses will borrow and spend less, thereby helping cool the economy and slow inflation.

The rise in borrowing costs has weakened the housing market, in particular. Sales of both new and existing homes are down sharply, and the pace of home construction in July sank to its lowest point since early last year. Similarly, retail sales were flat last month, with inflation and higher loan rates forcing many households to spend more cautiously.

Majority of Americans worry the U.S. is heading for a recession, survey finds 04:23

Under Chair Jerome Powell, the Fed is aiming for a "soft landing," whereby the economy slows enough to reduce hiring and wage growth without causing a recession and lowers inflation back to the Fed's 2% annual target. But by tightening credit even while the economy has slowed, the Fed is heightening the risk that its rate hikes will trigger a downturn. The surge in inflation and fear of a recession have eroded consumer confidence and fanned public anxiety about the economy.

Powell is set to offer his latest readout on the heath of the economy on Friday in an annual speech in Jackson Hole, Wyoming. 

In recent weeks, inflation pressures have begun to slow modestly, driven by a steady drop in gas prices from their lofty highs, along with lower measures of overall inflation. In July, consumer prices were 8.5% more than they were a year earlier, down from a 9.1% year-over-year jump in June. And on a monthly basis, prices were unchanged from June to July.

Still, the costs of many necessities, notably food and rent, have shown little sign of moderating and continue to squeeze millions of households.

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