Surprise US growth raises spectre of rate rise

The American economy turned in another astonishing performance in the second quarter of this year, defying expectations of a gradual slowdown by growing even faster than it had in the first quarter without any sign of worsening inflation.

The American economy turned in another astonishing performance in the second quarter of this year, defying expectations of a gradual slowdown by growing even faster than it had in the first quarter without any sign of worsening inflation.

The surprise rebound nevertheless raised the spectre of a further increase in US interest rates from their present nine-year high. Share prices fell, with the Dow Jones index down 56 points at 10,529.91 by midday.

Yesterday's figures showed a 5.2 per cent increase in GDP during the April-June quarter, faster than the revised 4.8 per cent figure for the first quarter. Earlier figures were revised higher, with growth in the last quarter of 1999 now recording a scorching 8.3 per cent.

Although the pace of the expansion has slowed compared with the end of last year, analysts were caught on the hop by the latest upturn. While most still expect, on balance, no move in the Federal Reserve's key lending rate, some warned there was now the possibility of a rise at its next policy meeting on 22 August.

David Jones, chief economist at Aubrey Langston in New York, said: "Certainly one has to say that it's an open issue whether the Fed has done enough in terms of tightening to achieve a soft landing. It makes the decision a closer call."

There is now a real prospect of interest rate increases in the US, the UK and the eurozone in the months ahead. Professor Charles Bean, the newest member of the Bank of England's Monetary Policy Committee, said yesterday UK rates might need to rise another half point.

Already cast as a "dove", Professor Bean said: "I would be surprised if interest rates have to go much above where they are at the moment." But he added: "It is quite possible there may be another half point or so."

Fresh signs of strength in the French economy added weight to expectations of a further move by the European Central Bank. Unemployment in France tumbled by 26,000 in June to a nine-year low, while business confidence soared to its highest since late 1994.

According to the Commerce Department figures, the US economy's strength in the second quarter was mainly due to business and government spending. Consumer spending growth slowed to 3 per cent from 7.6 per cent in the first quarter, the slowdown due mainly to a drop in car purchases.

However, business investment soared 19.1 per cent. Businesses also built up inventories.

Yet despite the sizzling pace of growth, the widest measure of inflation, the annualised rise in the GDP deflator, was just 2.5 per cent, down from 3.3 per cent in the first quarter. This allowed some analysts to remain optimistic the economy is on course for a soft landing without further interest rate rises.

However, the IMF yesterday repeated its belief that US interest rates could have to rise. It added a firm caution against tax cuts, favoured by Republicans in Congress, saying this would jeopardise the non-inflationary growth being enjoyed by the economy.