2.7% Growth in Quarter Quells Recession Fears

The nation’s economy grew at a healthy annual rate of 2.7% in the spring, substantially faster than the 1.7% growth rate reported a month ago for the second quarter, the Commerce Department said Tuesday.

The strong upward revision, which was largely expected by financial markets and economists, not only laid fears of recession to rest but it put within easy reach Administration forecasts of 2.9% growth for the whole year.

The economic growth rate was 3.7% for the first three months of 1989. For the first half of the year, the economy grew at an annual rate of about 3.2%.

However, the Commerce Department said in an associated report that after-tax corporate profits fell by a steep 6.4% from April through June for the second consecutive quarterly decline. That was a clear indication that businesses, especially in manufacturing, were unable to pass along labor and material cost increases, and it provided a worrisome signal of either future inflation or of a continued squeeze on industrial profitability.

Economists greeted the revised economic growth estimate soberly. They noted that much of the improvement was caused by higher-than-expected consumer spending, a factor that may deter the Federal Reserve Board from any further steps to ease interest rates.

“This was almost entirely consumer spending, but we had begun to see that from the retail sales reports from late spring,” said Bruce Steinberg of the Merrill Lynch investment house in New York. “The economy in late spring turned out to be a lot stronger than anybody expected, exactly at the time when the Fed was busily easing. Now, it’s likely that the Fed will delay any further action for quite a while.”

David Wyss of Data Resources Inc., a consulting firm in Lexington, Mass., called the revised economic growth rate “about what we expected, but with a lot more consumer spending than we first thought. There was also stronger investment, which is unambiguously good news. But the strong orientation toward consumption is not the preferred composition. It means the Fed will have a hard time easing any more.”

Lynn Reaser, of First Interstate Bancorp in Los Angeles, added: “These numbers are no basis for further easing by the Fed.”

Nevertheless, Reaser said, First Interstate is still looking for a marked slowdown for the rest of 1989--1% growth in the current quarter and a decline in economic activity in the year’s final three months.

The upside of that prediction, she said, is a belief that “inflation has peaked for the year and for this business cycle.”

Higher Inflation Plateau

Various inflation measures in Tuesday’s report were essentially unchanged from the earlier report, suggesting that inflation has hit a plateau higher this year than last, but not drastically so.

But some economists warned that more inflation is in the offing. The drop in corporate profits will probably force businesses to raise their prices later on, said Giulio Martini of the New York brokerage house of Sanford C. Bernstein & Co.

“With two quarters of declining profits, you have the problem of a margin squeeze: They can’t pass labor cost increases through,” Martini said. “That means a building pressure for higher inflation next year.”

The Commerce Department’s latest estimate of the economy in the second quarter pegged the total size of the nation’s economic output at $4.134 trillion in annual terms. It said the economy grew by an annual rate of $27.2 billion in 1982 dollars, compared with growth of $17.1 billion estimated a month ago.

Of the $10.1 billion in new-found growth, a whopping $7.1 billion was accounted for by higher consumer spending. The Commerce Department said that consumer spending grew at a 2.2% rate in the second quarter, another sign that Americans still would rather spend than save.

The nation’s trade position, as reflected in the economic report, remained about the same as it had appeared a month earlier. The overall trade deficit, including financial transactions and services as well as trade in merchandise, improved at an annual rate of $2.5 billion, from $55 billion in the first three months of 1989 to $52.5 billion in the second three months.