We are already in the second half of 2007. Thus, looking ahead we need to analyze how US economic growth will look like for the rest of 2007. The first quarter of 2007 was really dismal with growth in a “growth recession” territory (0.7%) and many components of aggregate demand either falling or growing slowly (net exports, residential investment, inventories, capex investment). The only strong component of aggregate demand was real private consumption surging 4.2% at annualized rate.

Given the excessive weakness of many components of aggregate demand in Q1 a rebound of inventories, capex spending and net exports in Q2 was expected. And indeed the mixed signals from the latest data on these variables suggest a Q2 growth rebound, to 2.8% according to the Blue Chip Economic Indicators consensus. Even if growth were to be as high as 2.8% in Q2 the average for the first half of 2007 would be a poor and subpar 1.7%

In spite of the rebound of some components of aggregate demand in Q2, some of the important factors for growth in Q2 ended up being the following ones: first, the housing recession did not bottom out and residential investment kept on falling at a sustained rate in Q2; second, there is now clear evidence of a significant slowdown in private consumption. Based on the latest available data, private consumption growth could turn out to be as weak as 1.5% in Q2, a sharp deceleration relative to Q1’s 4.2%.

Thus, the crucial issue for growth in H2 is whether this recent deceleration in consumption will continue in the second half of 2007. The Blue Chip consensus is for growth in the 2.8% range in H2. This optimistic outlook for growth for the rest of 2007 – that is embedded in the soft landing consensus - is crucially dependent on sustained consumption growth: indeed the continuation in H2 of the Q2 improvement in inventories and capex spending by the corporate sector hinges on private consumption remaining robust for the rest of the year. Instead,  if consumption spending were to remain weak in H2 – say close to the 1.5% growth of Q2 – the recovery of capex and inventories would not continue as weakness in the private final demand for consumption goods would lead to a further accumulation of unsold goods and a need to cut back on inventories, production and capital spending.

Note also that the significant weakening of consumption in Q2 is confirmed by latest weekly reports on same chain store sales. The International Council of Shopping Centers and UBS are projecting that June's sales at stores open longer than a year will rise a mediocre 1.5% to 2%, year over year; this means that they have fallen in real terms over the last year. For the latest week – ending on July 7^th, such sales rose only 0.1% in nominal terms after falling in some of the previous reporting periods. Moreover, Redbook Research announced that same-store sales last week were up only 0.8% from a year ago, another mediocre reading that is negative in real terms. So, early June data (official retail sales data will be available on Friday) suggest a dismal consumption performance last month after a May that recovered the retail sales losses of April. So April and June were real weak for retail sales and consumption while the growth in May will not prevent an overall weak quarter for consumption.

So the key issue ahead for GDP growth is: will the Q2 weakness in private consumption persist in the second half of 2007?

Private consumption depends on a variety of factors; and most of these factors now point to further weakness in consumption spending for the rest of 2007. The main determinants of private consumption are:
 

- Oil prices

- Wealth effects of housing and size of home equity withdrawal

- Interest rates and credit conditions in housing market and the  consumer credit market

- Consumer confidence

- Real wage and income growth and labor market employment expectations

An analysis of all of these factors suggests that the weakness of real private consumption in Q2 will continue in the second half of 2007 and that consumption growth may actually further deteriorate in H2. Clearly oil and gasoline prices are now rising putting a dent on real disposable income; further, home prices are falling and home equity withdrawal is shrinking at a rapid rate; while we already see evidence of a credit crunch in the subprime sectors and in other components of the mortgage market; consumer confidence is weak and falling recently. So, the case for resilience of private consumption hinges on continued growth of real incomes – now at risk because of high oil prices – and continued strength of the labor market. But, as discussed below, the true conditions of the labor market are currently weaker than those suggested by the official employment growth figures. Thus, real income and employment growth are not as strong as the consensus makes them. Thus, most of the determinants of consumption suggest weakness ahead.

Let us now consider in more detail each one of these factors that determine private consumption growth. There are five important issues to consider: