WASHINGTON -- Business inventories grew modestly in July, but analysts cautioned that it's still unclear how much inventory accumulation will slow in the third quarter and act as a drag on growth.

"That's a hotly debated topic right now," said Hugh Johnson, chief economist of First Albany Inc. "A key question for forecasters now is how fast will inventory growth slow."

Total business inventories increased 0.3% in July, the first month of the third quarter, to a seasonally adjusted $891.5 billion, the Commerce Department reported yesterday.

The July gain was less than the 0.5% advance that analysts had expected and was the smallest monthly increase since the first quarter when inventories slipped 0.2% in March.

Monthly inventory growth averaged 0.7% in the second quarter, when retailers, manufacturers, and wholesalers saw $56.3 billion in unsold goods pile up, much more than in previous quarters. That unexpected surge accounted for most of the 3.8% rise in second quarter gross domestic product, according to the government's most recent estimates.

Most economists predict that businesses will add less in the way of inventories this quarter compared with last, which would contribute to the much talked about and anticipated slowdown in growth in the third quarter. What isn't clear yet, though, is what the final numbers for inventory growth will be.

Henry Willmore, an economist with Chase Manhattan Bank, anticipates that inventory growth will remain relatively strong while growth in consumption picks back up after a slowdown in the second quarter.

Willmore predicted that businesses will add more than $40 billion to inventories this quarter, compared with the $56.30 billion total last quarter, and that growth in household spending will rebound to about a 3% annual pace. This, he said, would help to put third quarter growth at about 3% -- on the high side of most estimates.

Following a "strong burst" of consumer demand at the end of last year and the beginning of this year, "we could continue to see relatively strong inventory accumulation through the rest of this year," Willmore said.

But Veronika White, an economist with First Fidelity Bancorp, predicted slightly more of a drop-off in inventory growth and much less of a rebound in consumer spending, leading to 2% or less GDP growth in the third quarter. She forecast about a $35 billion gain in inventories, still relatively high compared with the recent quarters.

White said consumer spending is unlikely to grow much because it is already at high levels, reached earlier in the year. "Households are spending plenty of money," she said, adding that the expansion is reaching a mature stage when growth in most sectors typically begins to slow.

Johnson predicted that inventory accumulation in the third quarter may drop back to about the $25 billion gain recorded in the first quarter. "This would be a meaningful negative [regarding third quarter GDP] and would be offset to some extent by stronger consumption," Johnson said. His preliminary estimate has growth at 2% to 2.5% in the third quarter, about what he expects consumption growth to be.

According to yesterday's report, most of the gain in July inventories came in the manufacturing sector. Manufacturers' inventories jumped 0.9%, while wholesalers saw inventories rise 0.8%. Retail inventories fell 0.9%.

Total business sales dropped 0.8% in July, following a revised 0.9% increase in June, the department said.

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