Economic Growth May Be Too Tepid to Spark a Full Recovery

Federal Reserve Chairman Ben Bernanke told lawmakers on Wednesday that the U.S. economy is continuing to experience moderate growth, but economists suggest the rate of expansion during the second half of 2010 may be too low to spark a full-scale recovery. Though indicators confirm that the overall economy continues to show strength, the Fed's projection of 3.5% growth for the year may not be enough to satisfy the financial markets' hopes for a faster, more far-reaching rebound from the Great Recession.

The U.S. economy grew at a pace of 3% during the first quarter, and increased to a 3.3% rate in the second quarter. While that would be fine during boom times, it doesn't appear to be enough to reduce accumulated unemployment significantly, renewing fears that the U.S. economy might suffer a double-dip recession. Although Bernanke was generally upbeat in his testimony to lawmakers, he did confirm that unemployment would remain high for a "significant amount of time."

"Subpar" Growth

But high unemployment is just one of the major headwinds keeping the recovery from taking off in the second half of 2010. Fears over the European debt crisis, uncertainty over the affects of the BP (BP) oil spill, looming tax increases, the end of government stimulus spending and a possible slowdown in consumer spending are among the other challenges that will hamper U.S. GDP growth through the rest of this year and into 2011.

"The pace of growth since the start of the recovery has been subpar, with growth averaging about half the 6% to 8% one would expect given the depth of the losses that we endured," wrote Diane Swonk, chief economist of Mesirow Financial, in her midyear economic outlook.

While growth rates for many of the leading economic indicators such as housing, manufacturing and consumer spending have been moderate and are now beginning to slow or flatten, they nonetheless reflect positive economic trends that don't suggest a double dip.

For example, although GDP growth hasn't been strong enough to lift the economy out of the doldrums, it has beaten forecasts made at the start of the year. The Federal Reserve Bank of Philadelphia's survey of professional forecasters estimates that the economy will grow at a rate of 3.3% over the next two quarters, up from its previous estimate of 2.7%. It has also revised job growth projections upward over the next four quarters, predicting an unemployment rate of 9.5% in the fourth quarter of 2010, down from the previous projection of 9.7%.

Expiration of Bush Tax Cuts Could Be a Drag

While a double dip may not be coming, some economists still find the Fed's growth forecast of 3.5% for 2010 and 4% for 2011 a bit too optimistic.

"Sorry, I just can't buy into that," said Brian Bethune, chief U.S. financial economist for IHS Global Insight. "It would be nice, but it's just hard to see that happening."

Bethune is forecasting 3% GDP growth for the second half of 2010 and just under 3% for 2011. He contends that there are too many fiscal drags on the economy that will hinder growth prospects. He expects problems to arise from increased costs related to the new health care legislation, including higher premiums for businesses and higher costs for medications and medical devices. He also suggests that higher tax rates that could result from the end of the Bush tax cuts may also impair GDP growth through 2011.

"It's a recovery that's continuing, but we don't see any signs of acceleration," he said.

Too Many Temps, Not Enough Real Hires

Quincy Krosby, chief market strategist for Prudential Financial, says a great deal of what happens in the second half of 2010 will depend on job growth. An increase in hiring would immediately raise confidence in the economy and automatically boost consumer spending, which, as Krosby points out, accounts for roughly 71% of U.S. GDP.

Unfortunately, companies have been keeping their costs down by hiring more temporary workers, and with economic conditions so uncertain, it's unclear when they will shift to hiring permanent employees.

"The big fear in terms of the jobs market is that managers are going to just keep using temp workers as long as they can," says Krosby, who sees U.S. GDP growing between 3% and 3.5% into next year. "That's not something that will ultimately allow for strong growth in this country."

To accelerate growth in the second half of 2010, Bethune said it would take much stronger employment growth, a stronger housing market, and a stock market that is has sustaining upward momentum.

"A lot of things would have to come into alignment," he said.