U.S. Growth Outlook Improves, Rate Cut Less Likely, Survey Says

June 8 (Bloomberg) -- U.S. economic growth will gradually pick up through the end of this year, making the Federal Reserve unlikely to cut interest rates before 2008, according to economists surveyed by Bloomberg News this month.

Economists now forecast the economy this quarter will expand at an annual rate of 2.6 percent, compared with 2.2 percent projected last month and a 0.6 percent pace in the first quarter. The economy will expand at a 2.9 percent rate by the final three months of 2007, according to the median of 69 estimates in a survey taken from May 30 to June 7.

Increased spending on business equipment will help the economy mend after growth last quarter was the slowest in more than four years. Economists now expect Fed policy makers to delay trimming interest rates until next year, the survey showed.

``We've seen improvement in manufacturing and capital spending data, and that's taken away some of the gloomier scenarios for the economy,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York. ``Inflation numbers have been better but they may still bounce back again, and that's why the Fed can't cut rates.''

Rising commodity and labor costs, along with the forecasts for faster economic growth, prompted economists to nudge up their inflation forecasts. Consumer prices will rise 3 percent this year, up from 2.9 percent economists expected last month, the survey showed.

Outlook for Rate Cut

The Fed will leave its benchmark overnight lending rate at 5.25 percent until the second quarter of 2008, according to the survey. Economists last month forecast a 25 basis-point cut in the fourth quarter.

Policy makers ``cannot afford to be complacent,'' on inflation, Cleveland Fed President Sandra Pianalto said this week. She identified rising energy and commodity prices as possible threats.

Kansas City Fed President Thomas Hoenig in a speech this week said the current Fed target rate is ``modestly restrictive,'' likely to slow inflation while still allowing the economy to grow.

Last quarter, when growth was the slowest since the final three months of 2002, will probably mark the low point of the expansion, economists said.

Lacker Sees Rebound

Richmond Fed President Jeffrey Lacker this week reiterated his view that the economy will rebound as the effects of the housing slump gradually recede.

``The housing market is likely to find a bottom some time this year and no longer be a drag on top-line growth, business investment will pick up, and consumer spending will remain healthy,'' Lacker said in a speech in Frederick, Maryland.

Signs of improvements in manufacturing and corporate investment have helped allay concerns about the outlook. The Institute for Supply Management's factory index for May rose to the highest level in 13 months, and a government report this week showed orders for business equipment rose for a second straight month in April.

Economists lowered their forecast for unemployment to 4.7 percent in the fourth quarter from the 4.8 percent forecast last month. The rate was at 4.5 percent in May, close to a five-year low.

``The economy is steady, is solid, and many chief executives expect things will improve from here,'' Terry McGraw, chief executive officer of McGraw-Hill Cos., said in an interview June 5. McGraw-Hill is the owner of Business Week magazine and Standard & Poor's.

Threats to Growth

Threats remain that could undermine the economy, including a persistent housing slump, higher energy prices and a weaker dollar that could stoke inflation, McGraw said.

A rise in defaults among subprime borrowers, along with a glut of unsold homes on the market, may prolong the decline in housing. U.S. home sales and price declines this year are going to be steeper than earlier forecast, the National Association of Realtors said this week.

``The slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected,'' Fed Chairman Ben S. Bernanke said in remarks via satellite to a conference in Cape Town, South Africa on June 5. As subprime mortgage lenders make it tougher to get loans, that will ``restrain housing demand.''

Home construction subtracted about 0.9 percentage point from first-quarter growth. Economists said that even with the outlook for a protracted slump, housing will probably take away less from growth in the second half.

Gasoline Prices

Gasoline prices are also a risk to the outlook. The average price of a gallon of regular gasoline at the pump rose to a record $3.22 on May 23, according to figures from the American Automobile Association.

Declining home values and higher fuel costs pose a challenge to consumer spending that may limit the rebound in economic growth, economists said.

Such spending, which accounts for 70 percent of the economy, grew in the first quarter at an annual rate of 4.4 percent, the biggest gain in a year. It will slow to a 2.3 percent pace this quarter, unchanged from last month's estimate, according to the Bloomberg survey.

Spending will grow at a 2.5 percent rate by the fourth quarter, down a 10th of a percentage point from the prior survey. Growth in such spending has averaged 3.75 percent a quarter the past 10 years.

For the entire year, the economy is forecast to grow 2.1 percent, the slowest in five years.

``The economy is in transition from a growth slowdown to growth that's low to average,'' said Kurt Karl, chief economist at Swiss Re in New York.

By Joe Richter and Kristy Scheuble

To contact the reporters for this story: Joe Richter in Washington at jrichter1@bloomberg.net ; Kristy Scheuble in Washington at atanzi@bloomberg.net