By Brendan Murray, Al Yoon and Vivianne Rodrigues
New York, June 6 (Bloomberg) -- The U.S. economy is likely to remain ``sluggish'' into the third quarter, as businesses shed excess inventories and lower interest rates take time to revive consumer spending and investment, Federal Reserve Governor Laurence Meyer said.
``There are no signs yet that the economy is strengthening relative to its first-quarter performance'' of a 1.3 percent annual growth rate, Meyer told the New York Association for Business Economics.
``Growth is likely to remain sluggish into the third quarter'' and consumer spending may decline, he said. Inflation isn't an immediate threat, he said, suggesting the Fed may reduce interest rates later this month to boost growth.
Fed policy makers have lowered the benchmark overnight bank lending rate five times this year, most recently on May 15. The overnight rate is now 4 percent, the lowest in seven years and down 2 1/2 percentage points since the first of January.
The economy's response to those rate cuts ``should begin to mount in the second half, and continue to build in 2002,'' Meyer said. The U.S. will also benefit from lower energy costs and the just-passed tax cut. ``Energy prices should be moving lower,'' he said. ``In addition, fiscal stimulus is on the way.''
U.S. businesses have been firing workers as they see a prolonged period of slow growth. Hewlett-Packard Co., the second- biggest computer maker, today said it is ``more cautious'' about expected sales and profits than it was three weeks ago.
``This is a global economic slowdown which may last for quite some time,'' said Hewlett-Packard Chief Executive Carly Fiorina in a meeting with analysts.
Little Inflation Threat
Meyer said there is little immediate danger to the economy from rising prices. ``We probably don't have to worry about inflation for a while,'' he said, because the slowdown has left companies with excess capacity to produce goods and services.
Moreover, ``because the slowdown started from a relatively low level of inflation, the desirability of a significant decrease in inflation rates is not as great as it has often been in the past,'' he said.
Still, Meyer warned the Fed must avoid taking steps that would cause inflation to accelerate as it seeks to prolong the 10- year expansion. ``We have to be concerned that as we ease to mitigate the risks of a persistent slowdown or recession we do not at the same time create conditions that would lead to higher inflation as the expansion gathers momentum,'' he said.
Central bankers will ``have to pay more attention to overshooting in this case,'' Meyer said.
Abrupt Slowdown
Growth has slowed more abruptly than expected this year, as energy prices soared, lenders became more ``discriminating'' and stocks slumped, Meyer said. And the Fed's rate cuts have so far had ``only a little effect on aggregate demand,'' he said.
That echoes remarks of other Fed officials, whose comments have led investors to expect a sixth rate cut when the Fed's policy-setting Open Market Committee meets later this month.
``It's far from clear at this point that the economy is bottoming out, and if it continues to weaken, additional stimulus may well be needed,'' Richmond Fed Bank President Alfred Broaddus said yesterday.
Judging from trading in federal funds futures contracts, tied directly to the Fed's overnight rate, investors are counting on a quarter percentage point reduction at the June 26-27 meeting. That may understate the Fed's view, analysts said.
Larger Cut Likely
``The Fed is more open-minded about what they need to do than the market believes,'' said Jim Glassman, senior economist at J.P. Morgan Chase in New York. The expectation that the Fed will reduce the overnight rate by a quarter point this month ``seems just crazy to me given the data that we have seen,'' Glassman said.
Treasury securities rose following Meyer's remarks and stocks fell on concern that earnings growth will be sluggish. The 10-year Treasury note rose 3/32 point, pushing down its yield a basis point to 5.26 percent. The Dow Jones Industrial Average fell 106 points, or 0.9 percent, to close at 11070.24. The Nasdaq Composite Index fell 16 points, or 0.7 percent, to close at 2217.73.
One threat to the expected rebound in growth is a loss of investor and consumer confidence, Meyer said. The Nasdaq Composite has declined about 40 percent in the past 12 months.
Consumers have scaled back purchases this year and a ``soft labor market'' may undermine consumer confidence, he said. ``Growth in consumer spending is likely to remain below the pace of increase in income for a while,'' he said, though that would have the likely beneficial effect of increasing personal savings.
Business Investment
At the same time, business investment, which has declined in recent months, may be slow to recover, he said. ``We are unlikely to see a repeat of the unsustainable rise in equity prices or frenzied pace of investment, at least for a time,'' Meyer said. ``The events of the past year are likely to linger in the minds of many.''
The U.S. economy grew at a 1.3 percent annual rate in the first quarter, compared with growth last year of almost 5 percent, the Commerce Department said last month. It was the slowest first- quarter pace since the first three months of 1993, when the economy last showed a quarterly contraction.
More recent economic data show few signs of a quick turnaround in growth.
Yesterday, the National Association of Purchasing Management said its non-factory business index fell to 46.6 last month, the lowest on record, from 47.1 in April. A reading below 50 means business is contracting.