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Defense Spending Driving U.S. Economy

Thu July 31, 2003 10:23 AM ET

By Glenn Somerville

WASHINGTON (Reuters) - The biggest surge in defense

spending since the Korean War era helped drive U.S.

economic growth ahead at a surprisingly brisk 2.4

percent annual clip in the second quarter, the

Commerce Department said on Thursday.

The pickup in gross domestic product, or GDP, coupled

with a separate report showing a further decline in

new claims for unemployment benefits last week,

electrified financial markets as hopes grew that a

second-half revival was at hand.

The unexpectedly strong advance in GDP followed anemic

annual growth rates of 1.4 percent in each of the two

prior quarters. The second-quarter figures handily

surpassed Wall Street economists' forecasts for a 1.5

percent second-quarter expansion.

Separately, the Labor Department said the number of

new claims for unemployment benefits fell last week by

3,000 to a revised 388,000 -- the third straight

weekly decline and well below the psychologically

important 400,000 level.

Analysts said the data point to a fairly broad-based

economic strengthening, especially heartening with

Bush administration tax cuts forecast to add more

juice ahead.

"It's a positive indication that the economy is

recovering and that it was improving at a somewhat

faster rate than initially expected during the second

quarter, and that it would be likely that the rate of

improvement would increase going forward as the tax

cuts begin to hit," said Joe Stocke, a managing

director of Stoneridge Investment Partners LLC.

BRIGHTENS HOPES

Second-quarter GDP growth was the strongest since a 4

percent rate of increase in the third quarter last

year.

"Growth in the second quarter was boosted by federal

defense spending, by business investment in plant and

equipment, and by consumer spending," Commerce noted.

Spending on defense, much of it to support the war in

Iraq, shot up at a 44.1 percent rate -- the strongest

since 110 percent in the third quarter of 1951 --

after falling 3.3 percent in the first three months of

the year.

Economist James Glassman of J.P. Morgan Chase in New

York said both GDP and lower jobless claims were

"quite promising" in the sense of implying that

consumers and businesses saw better times ahead, even

if growth is still below what is needed to reduce the

unemployment rate.

"On GDP the trend is not impressive and no one was

expecting it to be impressive but the composition of

growth is, and it just reinforces the optimism about a

second-half pickup," Glassman said.

The dollar's value climbed against other major

currencies after the GDP data, in the apparent belief

a U.S. economic rebound will outstrip those in other

major regions and make U.S. investments relatively

more attractive.

On Wall Street, stock prices bounded higher on the

positive economic news, while bond prices tumbled in

expectation investors would find equities a better bet

for future gains.

Business investment, which has lagged during the slow

expansion from the 2001 recession, showed definite

signs of revival in the spring quarter.

Nonresidential spending -- the broadest category of

investment -- rose at a 6.9 percent annual rate in the

second quarter after decreasing 4.4 percent in the

first three months.

Consumer spending, which fuels two-thirds of national

economic activity, added to the second-quarter pace of

expansion. Spending, especially on new cars and other

costly durable goods, climbed to a 3.3 percent rate

from 2 percent in the first three months of the year

and was the strongest since a 4.2 percent increase in

the third quarter of last year.

CHEAP CREDIT HELPS

The Federal Reserve, which has cut U.S. short-term

interest rates to 45-year lows in a bid to spark a

stronger recovery, said on Wednesday it saw signs in

June and early July that a more vigorous pace of

growth was budding as manufacturing activity grew.

"Several districts noted increased optimism about

economic prospects in coming months," the U.S. central

bank said, adding it saw "nascent signs of a recovery"

among manufacturers, which have shed an estimated 2.6

million jobs since mid-2000.

Businesses reduced inventories at a .9 billion

annual rate in the second quarter after building them

up at rates of .8 billion in the first quarter and

.8 billion in the final three months last year.

Slimmed-down inventories generally are considered

promising for the future, since it means companies

must quickly ramp up production and potentially hire

more employees once stronger demand is firmly

established.