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Economists now expect moderate growth: not rosy rebound

Workers check television sets before they are repackaged at Element Electronics in Winnsboro, South Carolina.

Economists expect a bounce back in the second half after first quarter GDP was revised to a decline of 2.9 percent, the worst drop since the Great Recession, based largely on a steep downward revision in health-care spending.

2014 is now setting up to be a year of moderate growth, not the rosy rebound many economists expected. Second quarter growth, expected at about 3 percent, means that the first half of 2014 could show no growth at all. Expectations are for higher growth rates of 3 percent or more for the third and fourth quarter. That would still mean growth for the year could be just about 2 percent or less.

"Certainly the weather was a big factor in the first quarter. The number would be much less negative if it weren't for the weather. The magnitude of the bounce back in the second quarter doesn't look like it will be as explosive as one would expect," said Stephen Stanley, Pierpont Securities chief economist.

Q1 GDP down 2.9%, May durable goods down 1%

The big drop in revised GDP was largely due to a sharp reversal in consumer spending and a smaller-than-expected contribution from exports. The contribution from consumption went from 2.1 percent to 0.7 percent, and within that number health care was a large drag. The initial estimate in first quarter GDP was a positive 1 percent for health-care services but that fell to a decline of 0.2 percent.

Stanley said the government had initially estimated a big increase for health-care outlays under the assumption that many individuals had signed up for coverage under the Affordable Care Act.

Stanley said he expects just 2.5 percent growth for the second quarter, which would imply a contraction for the first half of the year.

Economists had expected a decline of 2 percent for the first quarter, revised down from the last reading of a 1 percent decline. The 2.9 percent drop signals the weakest growth since the first quarter of 2009, when GDP contracted by 5.4 percent.

Early government forecasts were for an increase in health-care spending in the first quarter. But Barclays noted that the main cause of the downward revision was in medical services consumption, reduced from a 9.1 percent annualized growth rate to a 1.4 percent annualized contraction.

"It turns out health-care spending was actually down in the first quarter. From that, we knew there would be a big downward revision in consumption," said Stanley.

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While severe winter weather was blamed for much of the decline, Stanley said the inventory building and surprisingly strong trade numbers in the second half 2013 reversed and were a big drag on the first quarter.

"We've only had a couple of times in the post-war period where the economy has given you this type of drop without being a recession or about to go into a recession. It's highly unusual," said Deutsche Bank chief U.S. economist Joseph LaVorgna. He expects a bounce back in the second quarter based on the job growth of about 190,000 per month, improved industrial production and manufacturing activity and slightly better retail sales.

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"This sets ups up for a very solid Q2 payback but how much remains uncertain," LaVorgna said, adding that he expects growth of 3.8 percent for the remainder of the year, and 2.1 percent for the year.

"By default the numbers for the year are going to be much lower," said LaVorgna.

One strong sign on Wednesday was with the services sector. It expanded in June at the fastest pace in at least 4½ years, pushed higher by increasing business activity, according to a survey from financial data firm Markit.

—By CNBC's Patti Domm.