With the second half of the year just beginning, economists are questioning if the worst of the U.S. downturn is already over, or whether uncertainty about rising prices spells more gloom and doom for the economy.

Thursday's BLS nonfarm payrolls report for June showed the sixth month of consecutive declines in the U.S. economy, totalling 438k net losses this year and indicating further deterioration is to come. However, economists say it is not job losses that are the major concern heading into the third quarter, but rising prices.

While there is pressure for the Fed to combat inflation, the central bank remains constrained not only by broad-based, anemic growth, but by the fact that soaring energy prices are caused by increased global demand rather than by U.S. consumers.

Charmaine Buskas, senior economics strategist at TD Securities, said the first half of 2008 "didn't see as much fallout as we would have expected," noting that the downswing in jobs was much weaker than in previous downturns. She noted job losses have yet to exceed 88k per month, whereas previous downturns have reported monthly declines of more than 100k and even as many as 200k, which "suggests recent deterioration has been tame."

Similarly, Ellen Zentner, U.S. macroeconomist at the Bank of Tokyo-Mitsubishi, said, "The point is: this is still nothing like previous recessions."

Back in May, Zentner said the labour market remained "bullish" even as a general recession loomed. She called the labour market "soft but not horrible," commenting that the U.S. is clearly in recession but with only mild job losses.

Following Thursday's nonfarm employment report, which added 50k more losses in revised estimates for the previous two months and held the unemployment rate at 5.5%, Zentner said the story is still the same, noting that the widely-watched three-month moving average of job losses was worse in March than it is now.

She expects job losses to continue in the medium term, but the bigger concern going forward is inflation, which she expects to be "just nasty" in the third quarter.

Meanwhile, Buskas is looking for Q3 inflation to rise to 4.6%, up from an estimated 4.1% in Q2. She said oil prices should fall back by the end of the year as the economic slowdown in China should continue and thereby soften demand for energy, while speculative forces that have been driving up rising prices should come down.

But Dave Resler, chief economist at Nomura Securities, said "the persistent upward pressure on energy costs has necessitated discarding (the) optimistic assumption (that energy prices would see a reversal.)" As a result, he's made "a major revision to the outlook," in which he now expects CPI inflation to rise by an average 4.0% over the next six quarters, "including a surge to 6.3% in the third quarter of 2008."

Resler's forecasts, while gloomy, are based on oil prices remaining at "near recent levels, but below this week's highs." Yet, to some economists, even that expectation is too optimistic.

"If oil prices continue on trend, you're talking about 10% headline inflation in Q3," Zentner said.

Her reasoning is based on oil prices averaging $124 per barrel in the second quarter, compared to just under $98 in Q1. This represents a 27% gain in a single quarter. If prices rise at just half that pace in the third quarter, oil prices will average $140, she said, noting her own estimate is closer to $150.

"This isn't being pessimistic; this is being realistic," she added, forecasting that Q3 headline inflation will be between 7% and 10%, depending on energy prices.

Zentner said the global nature of rising energy prices puts the Fed in a difficult position seeing as how U.S. consumers aren't driving up prices, so the usual reasons to hike rates are largely inapplicable.

"Usually when inflation is high, everything else in the economy is tight. We don't have any of that right now. Margins are getting tighter and profits are falling," she said. This puts producers in a difficult position, as an attempt to pass on their rising prices would likely result in much less demand seeing as how consumers' discretionary spending is eaten up by rising food and energy costs.

"Typically, when the Fed is dealing with these issues they are dealing with a price-wage spiral," but that's not the case this time, Zentner said. "The labour market is slack, and getting slacker. There are no wage pressures - it's not an employees' market."

By Patrick McGee and edited by Nancy Girgis