By DAVID LEONHARDT
Published: July 30, 2005
The New York Times

Businesses and households went on a shopping spree this spring, causing warehouse stockpiles to shrink and setting the stage for faster economic growth during the rest of the year.

The spending helped extend a solid if unspectacular expansion in the second quarter, when the economy grew at an annual rate of 3.4 percent, the Commerce Department reported yesterday, down from 3.8 percent in the first quarter.

Companies took advantage of the weaker dollar to ship more goods abroad, while imports reversed course and fell slightly. It was the first time since 1991 that exports rose and imports dropped in the same quarter.

In a sign of better times to come, housing construction, consumer spending and corporate investment increased more rapidly this spring than production did, causing inventories to decline sharply. Economists said companies, especially carmakers, were likely to accelerate production in the second half to rebuild their stockpiles, lifting overall growth.

"When you've got a decline in inventories this large, it's unintended," said David Greenlaw, an economist at Morgan Stanley. "Now producers will start to play catch up."

Forecasters said yesterday's report would lead them to raise their growth projections for the rest of the year; Morgan Stanley now expects growth of better than 5 percent during the third quarter, up from an earlier prediction of 3.7 percent. In the second quarter, growth exceeded 3 percent for the ninth consecutive quarter, the longest such streak since the mid-1980's.

The yield on 10-year Treasury notes rose to 4.28 percent yesterday from 4.19 percent on Thursday, as investors apparently took the healthy growth as a signal that the Federal Reserve would keep raising its benchmark interest rate to keep inflation tame.

The steady expansion has continued over the last year despite two problems that have often derailed economies in the past. Oil prices have spiked and now hover around $60 a barrel, their highest level in inflation-adjusted terms since the early 1980's. And the job market, while improving, remains weak enough that wage growth trails inflation for most workers.

In a separate report, the Labor Department said yesterday that wages and salaries rose 2.4 percent during the 12 months that ended in June.

The high cost of health care is one reason companies are trying to avoid giving raises; benefit costs increased 5.1 percent over the last year, the government reported. Overseas competition has also hurt wages.

"There are still a lot of price pressures and margin pressures on businesses," said Bill Zadrozny, chief executive of Siemens Financial Services, which lends money to businesses. "Being able to pass through costs is not easy."

Inflation has been running about 3 percent recently.

Consumer spending slowed slightly during the quarter, one reason that overall economic growth dropped somewhat.

As part of its regular revisions, the Commerce Department announced that the economy did not perform quite as well between 2002 and 2004 as had initially been estimated. Last year, it expanded 4.2 percent, not 4.4 percent.

But the housing boom has been strong enough to make up for many of the economy's other problems. The building of new houses in the Southeast and the West has created thousands of jobs, while soaring home values in California and the Northeast have allowed homeowners to take on more debt and increase their spending.

Residential spending grew at an annual rate of 9.8 percent in the second quarter, up from 9.5 percent during the first three months of the year, the Commerce Department reported.

Housing has become important enough that a sharp rise in mortgage rates could potentially halt the economy's expansion. So far, though, mortgage rates, which are set by investors, have remained low even as the Fed has lifted its benchmark rate to 3.25 percent from 1 percent at the start of last summer.

"Anybody who was still holding out hope that they were almost done probably has to throw in the towel" after yesterday's report, said Joshua Shapiro, the chief United States economist at MFR, a research company in New York. "Things are shaping up for a second half of the year that's quite perky."

Many analysts expect the Fed to raise the benchmark rate to about 4 percent by the end of the year. That would put some pressure on mortgage rates, but a host of other factors, including the growth of China, will probably keep them from spiking soon, economists say.

The corporate sector's recovery from the aftermath of the 1990's bubble also helped growth in the spring. Spending on new equipment and factories rose at annual rate of 9 percent, up from a 5.7 percent increase in the first quarter and roughly matching the growth rate in 2004.

Those good times seem poised to continue. A survey of Midwestern purchasing managers released yesterday offered some early evidence of the growth spurt that could come from the recent fall in inventories. Production and new orders both surged in July, after having slowed for much of the spring, according to the Chicago branch of the National Association of Purchasing Management.

In the second quarter, final sales - a measure of economic growth that does not take inventories into account - grew at an annual rate of 5.8 percent. In only one other quarter since 1999 has the increase been so large.

The fall in the nation's trade deficit was good news for workers, executives and policy makers who have grown concerned that the United States does not make enough of what it buys. Together, imports and exports added 1.6 percentage points to the quarter's growth; in previous recent quarters, they had shaved between 1 and 3 percentage points off growth.

But economists said the turnabout was unlikely to be permanent. The dollar has risen in recent months against the euro and the yen, and there is still little sign that the economies of Europe or Japan are on the verge of a burst in growth.

"The U.S. is growing faster than the rest of the world," Mr. Greenlaw said. "It's very difficult to cut into your trade deficit in that environment."

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