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Second-Half Recovery Thesis Remains, Though Strained

The first-quarter GDP revision doesn't wring out all hope.

Despite a slightly worse-than-expected report on first-quarter growth, economists are generally still clinging to hopes for an economic recovery in the second half of the year.

There are several reasons for optimism. Monetary and fiscal policies are attractive. The housing market is strong. And corporate activity is showing signs it might pick up. "The adjustment to excess investment in the late '90s is progressing nicely," said Mike Moran, an economist at Daiwa Securities. "We are seeing spending on high-tech equipment increasing."

In the first quarter, GDP growth was revised a half-percentage point lower to 1.4%, reflecting less inventory investment and more imports than predicted a month ago. Inventories grew at a $4.8 billion rate, almost a third less than the $13.2 billion previously forecast. They are at historically lean levels.

"Because inventories are so lean, we are going to get a bigger kick than previously thought from a pickup in business investment," said Moran, who expects 3.5% GDP growth in the second half.

Moran's thesis would be challenged by further prudence by corporations. "It takes a while for business executives to get up the confidence to invest in capital equipment. They are behaving very cautiously. That cautiousness might fade more slowly than I expect."

In a positive sign, new orders for durable goods, excluding transportation, were up 0.2% in May. Still, total orders for manufactured goods fell by 0.3% to $168.3 billion, their lowest level in a year.

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"We still have problems in terms of overcapacity," said John Shin, an economist at Lehman Brothers, although he is also forecasting 3.5% GDP growth in the second half of the year.

In Shin's view, monetary policy is going to be an important factor contributing to growth. On Wednesday, the

Federal Reserve

lowered interest rates by a quarter-point to 1%, their lowest level since 1958, saying that the economy has not yet exhibited sustainable growth.

The Fed's latest move, some economists argue, could help consumer spending in the coming months.

Meanwhile, many of President Bush's tax cuts will take effect in the second half of the year, with some relief going to state and local governments. The tax cuts will add to the budget deficit. But in the near term, some aren't worried. "In such a soft recovery, deficit spending is not inappropriate," said Shin.

Tax cuts are expected to add 1% to GDP growth this year. But economists are not predicting a return to anything close to the gangbusters GDP growth of the late 1990s. "Growth is still tepid," said Shin.