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Last Updated: Friday, 28 July 2006, 15:08 GMT 16:08 UK
Brakes slam on US economic growth
Person sleeping in a hammock in front of a US flag
US consumers seem to be taking a rest from their hard spending
The US economy, the world's largest, has slowed in the second quarter of the year, on the back of rising interest rates and soaring energy costs.

Gross domestic product (GDP) grew at an annual rate of 2.5% in the three months to the end of June, compared to a 5.6% annual rate in the previous quarter.

Some slowdown had been expected, but its severity comes as a surprise.

The US dollar dropped on the news, as analysts questioned their forecasts for annual US economic growth.

The Federal Reserve predicts that the US economy will expand by 3.5% this year, compared with a growth rate of 3.2% in 2005.

Big question

Shaun Osborne, a strategist at Scotia Capital, said that Friday's Commerce Department report would "probably underpin expectations that US growth will slow quite sharply in the second half of the year and into 2007".

One of the main factors in the recent slowdown in growth has been a weakening of consumer activity.

As a result, many analysts are now predicting that the Federal Reserve, the US central bank, will put off interest rate increases, despite inflationary pressure from the high energy costs.

The Fed has been slowly raising its borrowing costs as the economy has picked up pace, lifting interest rates 17 times in a row to 5.25%, the highest level in more than five years.

"The question that's been overhanging the financial markets is whether the Fed will tighten again," said David Resler, an economist at Nomura Securities.

"This says not and this says why. Consumer spending has slowed fairly significantly," he added. "I see very little reason for the Fed to do anything in August."

Still lingering

US stock indexes rose in New York as investors bet that interest rates would not rise further. Fears that higher borrowing costs would squeeze corporate profits had prompted a global stocks sell-off last month.

However, the worries have not dissipated completely and the report on GDP showed that a closely-watched inflation measure had increased.

According to the report from the Commerce Department, core prices - excluding food and energy - increased at an annual rate of 2.9% in the second quarter, as opposed to 2.1% in the first three months of the year.

Personal consumption expenditures (PCE), meanwhile, increased by 4.1%, more than double the 2% rate of the preceding quarter.

A separate report from the Labor Department showed that it was becoming more expensive for employers to hire and keep workers, another factor that may also fuel inflation.

Michael Metz, an analyst at Oppenheimer Holdings, said that while the consumer had proved to be "pretty resilient", that could change if inflation and rates keep rising.

And that would have further negative effects on the rate of economic growth, he added.

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