COMMERCE BANK ECONOMIC REVIEW - JULY 2007

 "The slowdown is behind us, but continued solid growth is not baked in the cake."

By Joel L. Naroff, Ph.D.

The economy hit an air pocket during the first part of the year. Growth was barely perceptible and there were worries that we could slip below the waves. That did not happen. But, while the weak inherited the leadership banner, the strengths showed signs of fatigue. Thus, although we may like the second quarter growth rate, there is no guarantee that it will be repeated in the second half of the year.

The economy flowered in the spring. Companies that had been cautious and drawing down inventories decided the worst was behind us. They ordered more goods and the manufacturing sector picked up steam. Indeed, the Institute for Supply Management’s reading on the industrial heartland was the strongest in over a year. Similar readings for the service sector made it clear that the growth was fairly broad based.

The improvement in business activity translated into good news for workers. Job growth over the past three months has been quite solid. And the unemployment rate remains at a low 4.5%. As a consequence, paychecks are finally fattening at a respectable pace. This is critical, because consumer spending was the key to keeping us out of negative growth during the first quarter. 

Which brings us to the key question: Will households stay the course and spend all they have? When it comes to income, consumers have the means to keep things going. But we are seeing some cracks in the front. While May retails sales were solid, June motor vehicle demand was not a pretty sight. And it was booming durable goods demand that boosted the economy. That may be behind us.

In addition, there is the small thing called food and energy. For Washington politicians, ethanol seems to be the answer to everything. Unfortunately, when you cause the demand for a good to surge, the price is likely to rise. And it has. Corn prices have skyrocketed and that is raising the costs for other farmers and food manufacturers that use corn or corn-based products in making their goods. So food costs are way up, while gasoline prices are not down. Indeed they are rising again. If you eat, drive your vehicle or are trying to keep cool in the summer heat, the bills have become ugly.

The higher inflation has not gone unnoticed by the bond markets. Longer term interest rates have gone up to levels we haven’t seen in more than a year.  And the Federal Reserve keeps pointing to inflation as the major reason they are not lowering rates.  Indeed, it now appears that the Fed could remain on hold for a lot longer than expected. 

So, where do we go from here? The economy may have rebounded, but an extended period of strong growth does not look to be in our future. Manufacturers have rebuilt inventories and that push to the economy is likely behind us. Consumers have the money to spend, but it is not clear they are doing that as they face rising food and energy costs.  And the housing market continues to be a major restraining factor. Basically, it looks like the economy will grow modest to moderately the rest of the year. 

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, America’s Most Convenient Bank, is a leading financial services retailer with nearly 450 convenient stores in New Jersey, New York, Connecticut, Pennsylvania, Delaware, Washington, DC, Maryland, Virginia and Southeast Florida. Commerce Bancorp (NYSE: CBH) is headquartered in Cherry Hill, NJ and has more than $47 billion in assets. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.