The economy grew at a 3.0 percent rate in the second quarter, as the sharp rise in imports in the first quarter was more than reversed in the second quarter. The second quarter figure brought the growth rate for the first half to 1.2 percent, down from 2.8 percent in 2024.

The fall in imports added 5.18 percentage points to the quarter’s growth after subtracting 4.66 percentage points in the first quarter. This rise in GDP was partially offset by a reversal in the inventory buildup in the first quarter, with inventories subtracting 3.17 percentage points (pp) from growth after adding 2.59 pp in the first quarter. Final sales to domestic purchasers, which excludes both net exports and inventories, grew at a 1.1 percent rate, down from a 1.5 percent rate in the first quarter.  

Consumption Growth Remains Weak

Consumption grew at just a 1.4 percent rate in the second quarter after rising at a 0.5 percent rate in the first quarter. This brings its average over the first half to just 0.9 percent, down from 3.4 percent in 2024.

Durable goods consumption led growth, rising at a 3.7 percent rate after dropping the same amount in the first quarter. Car purchases were driving this growth, rising at a 16.3 percent rate after falling at an 11.2 percent rate in the first quarter.

Service consumption grew at just a 1.2 percent rate, down from a 1.6 percent rate in the first quarter. Part of this weakness was a 12.8 percent rate of decline in real spending on electricity, largely reversing a 22.7 percent weather driven jump in the first quarter.

However other areas of spending were also weak. Housing consumption rose at just a 1.2 percent rate. Spending on air travel fell at an 11.7 percent rate in the quarter and an 8.5 percent rate for the first half as whole. Restaurant spending rose at 1.6 percent rate in the first half as a whole, while spending in fast food restaurants fell at 0.1 percent rate.

Non-Residential Investment Grows at 1.3 Percent Rate

Rises in equipment investment and investment in intellectual property products managed to offset a 10.3 percent decline in structure investment. The drop in structure investment was driven largely by drops in investment in factory and hotel construction.

Factory construction fell at a 5.6 percent annual rate in Q2, after falling at a 1.3 percent rate in the first quarter. This likely is the result of the completion of many projects kicked off by the Biden legislation. This drop is likely to continue, especially if construction of some factories is stopped due to the ending of clean energy incentives. Hotel construction fell at a 14.2 percent rate in the quarter.

Equipment investment rose at a modest 4.8 percent rate, driven in large part by a 50.3 percent jump in computer investment, following a 122.4 percent increase in the first quarter. These rises likely reflect an effort to get ahead of future tariff increases.

Investment in intellectual property products rose at a 6.4 percent rate. This was driven entirely by a 16.4 percent rise in spending on software development, likely due to AI. Spending on both research and development (largely pharmaceuticals) and cultural products both fell in the quarter.

Housing Construction Declines Again

Residential investment fell at a 4.6 percent rate after dropping at a 1.3 percent rate in the first quarter. High interest rates and economic uncertainty are clearly weighing on the sector. The loss of immigrant workers may also be a factor weakening construction.

Improvement in Trade Entirely Due to Lower Imports, Exports Fall 1.8 Percent in Second Quarter

The reduction in the trade deficit was entirely attributable to the sharp drop in imports, which more than reversed the first quarter rise. The drop in exports was driven entirely by lower exports of goods, which fell at a 5.0 percent rate in the quarter. Real spending by foreigners traveling in the United States also fell. It declined at a 15.0 percent rate in the first half of 2025.

Government Spending Grew at a 0.4 Percent Rate After Declining at 0.6 Percent Rate in First Quarter

Government spending has been weak this year mostly due to a 4.6 percent drop in federal spending in the first quarter (driven mostly by lower defense spending) and 3.7 percent drop in the second quarter. Spending at the state and local level, which accounts for most government spending, rose 2.0 percent and 3.0 percent, respectively.  

Inflation Remains Above Fed 2.0 Percent Target

The core PCE deflator rose at a 2.5 percent rate after rising at a 3.5 percent rate in the first quarter. While this is not an especially high rate, it is above the Fed’s target. More important from the Fed’s standpoint is that inflation no longer seems to be moving towards the Fed’s target. In its last set of projections last fall, the median forecast for the core PCE deflator for 2025 was 2.3 percent. The highest individual forecast for the core was 2.6 percent. Given the 3.0 percent average for the first half, we seem on a path to be well above the highest individual forecast for inflation this year.

Productivity Growth Likely to Be Slow for the Quarter

Productivity growth in the first quarter was just 1.3 percent. This is down from 2.1 percent rate in 2024 and 1.9 percent average rate for the pandemic recovery as a whole (4th quarter 2019 to 4th quarter 2024).

The rate of hours growth likely was slightly over 2.0 percent in the quarter, which would translate into productivity growth close to 1.0 percent. Productivity data are notoriously erratic and subject to large revisions, but a slowdown from somewhere close to 2.0 percent to somewhere close to 1.0 percent would be very bad news from the standpoint of real wage growth and inflation.

Weakening Consumption Growth Is Likely to Be a Drag on Growth in the Rest of the Year

Consumption growth was unusually weak through the first half of this year. This reflects in part slower real wage growth and slower employment growth. It likely also reflects increased uncertainty about the future as workers are more worried about their jobs and tariffs will be raising prices.

Government spending is weak by deliberate policy and investment is rising at a modest pace as the end of the factory construction boom is a substantial drag. The near-term prospects do not look good.