US Economy May Face Bigger Risks Due to Oil, Mideast Unrest

A Lebanese woman looks at a destroyed apartment building following Israeli air strikes in the southern Lebanese city of Tyre (AFP Photo)

The upsurge in Middle East violence and resulting spike in crude oil prices poses new risks to the US economy, which is already cooling from higher interest rates and other factors, experts say.

With concerns rising about an expansion of the conflict now involving Israel and Lebanese-based Hezbollah, oil prices have hit fresh peaks, increasing a variety of costs at a time when many analysts have been calling for a "soft landing."

Recent reports on retail sales and consumer sentiment suggest the world's biggest economy is already retreating from its strong 5.6 pace of growth in the first quarter. But a jolt from energy costs could make the landing a lot bumpier.

"Given the unnerving developments in the Middle East, the prospects for 80-dollar oil and record gasoline prices, a clearly deteriorating job market in the US and the steady erosion in the stock market, it stands to reason that households will be much more cautious about spending in the future," said Bernard Baumohl, executive director of the Economic Outlook Group.

"The US has suddenly become vulnerable to a much more serious downturn in the second half of the year. Could geopolitical events suddenly turn a soft landing into a recession? Absolutely."

The latest developments pose new challenges for the Federal Reserve, which is trying to curb inflationary pressures even as the expansion cools.

Goldman Sachs analysts said in a note the recent data "point to slower growth." The investment group is calling fro 3.0 percent growth in the second quarter but add that "the slowdown in retail sales over the past few months -- as well as more anecdotal measures of business confidence -- suggest that the risks to a trend growth pace in coming quarters are on the downside."

"The more economic data we get, the more we see that economic growth is slowing," said independent economist Joel Naroff.

"The more inflation data we get, the more we see that inflationary pressures are building."

Oil prices can cut into US consumer spending by forcing consumers to spend more on gasoline and heating costs. This is expected to hurt big retailers like Wal-Mart.

But experts point out that consumer spending still accounts for the vast majority of economic activity.

"The 70 percent of the US economy known as consumer spending is buckling," said David Watt, senior economist at BMO Nesbitt Burns.

Watt argues that the Fed and new chairman Ben Bernanke risk choking off the economy if they continue to raise interest rates after 17 consecutive quarter-point hikes in the federal funds rate.

"Now, if only Chairman Bernanke could convince the market that a pause is not a sign that he is a wimp when it comes to fighting inflation," he said.

Some analysts say the economy is already seeing a mild form of "stagflation," or stagnant conditions with rising prices.

The stock market has been tumbling and bond yields falling, presaging for some a slowdown that is more serious than previously anticipated.

Other analysts say these fears are overblown and that the US economy had held up in the face of numerous shocks.

Global Insight economists Nigel Gault and Brian Bethune said in a report they are raising their forecast for second quarter growth from 2.3 percent to 3.3 percent in "a testimony to the underlying resilience of the economy in the face of some pretty nasty shocks."

Brian Wesbury at FT Advisors said the economy's underlying strength is better than it appears.

"We expect retail activity will pick up in the second half of this year as a strong job market and rising incomes offset the impact of elevated energy prices," he said. "Our forecast for real GDP growth in the third and fourth quarter remains at 3.5 to 4.0 percent."

Source: AFP

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