U.S. unemployment falls below 7 percent 18-month low may prompt Fed to raise interest rates

June 05, 1993|By Gilbert A. Lewthwaite | Gilbert A. Lewthwaite,Washington Bureau jTC

WASHINGTON -- Unemployment broke below the 7 percent level in May, signaling a strengthened recovery and flashing a fresh warning to the Federal Reserve that higher inflation could be on the way.

The jobless rate dropped to 6.9 percent last month from 7 percent, an unexpected reduction to the lowest level in 18 months. Even more surprisingly, 209,000 jobs were added to company payrolls during the month, as employers stepped up hiring in anticipation of increasing demand. That was almost double the number expected.

Pointing out that defense cuts at home and recession abroad were still depressing the recovery, Rudolph Penner, director of economic studies for KPMG Peat Marwick and a former director of the Congressional Budget Office, said: "If it weren't for those things, you would probably have a very robust recovery here."

May's employment jump was led by a surge of construction jobs after bad weather in the early months had restricted building. The lowest interest rates in 20 years are increasingly luring home buyers back into the market, putting the industry back into stride. The Labor Department announced that 67,000 construction jobs were created last month.

The service sector, led by expansions in health and business-related employment, added 126,000 jobs.

But the crucial manufacturing industry, where the best-paying jobs traditionally lie, shed 39,000 workers for a total decline since February of 133,000.

"That's the reason why the report would still give you an economy growing close to 3 percent this year," said Kathleen Stephansen, economist with Donaldson, Lufkin, Jenrette Securities Corp, New York.

"Had the growth in job creation been in manufacturing you would have had to conclude the economy was growing at a 4 percent rate. There is a big, big difference here in terms of direct impact on economic growth."

The good employment news yesterday was tempered by the announcement that U.S. factories received fewer new orders in April, compounding a falloff in March. Orders fell 0.3 percent following a sharp 1.6 percent drop in March, the Commerce Department said, registering the first back-to-back decline since July and August last year.

But economists said the drop in factory orders reflected the working off of involuntary inventories built up earlier in the year. Once these were out of the way, new orders should also start to increase.

Analysts said the strengthening economic outlook evident in the jobless figures would give the Fed, already leery of a spurt in inflation, additional impetus to react to further price increases by raising short-term interest rates by perhaps one-quarter of a percentage point.

"It sort of gives the Fed a launching pad," said David Jones, chief economist of Aubrey G. Lanston, a New York securities dealer.

An increase in the federal funds rate, the amount charged by banks for overnight loans to each other, which is now 3 percent, is not expected to come before the next meeting of the Fed's policy-setting Federal Open Market Committee (FOMC) next month.

At its May 18 meeting, the FOMC, alarmed by an annual inflation rate of 4 percent during the first months of 1993, gave Fed Chairman Alan Greenspan authority to raise short-term interest rates by up to one-half percentage point if necessary.

But inflation is expected to retreat for a while. It could be August or September before it shows renewed strength, which would then likely bring prompt Fed action.

"I am assuming Greenspan will have a little bit of a breathing space here," said Mr. Jones. "But he certainly will be on guard for any meaningful [inflation] numbers, and the next significant increase would bring tightening."

The Fed will also be watching the employment figures, hourly earnings,and consumer spending rates as leading inflation indicators. All have registered increases in recent weeks, suggesting a self-sustaining growth cycle has clicked into gear.

Donald Ratajczak, director of the Economic Forecasting Center at Georgia State University, said: "The Fed is nervous. . . . The trend is starting to get nerve-racking. It's not screaming at you, but it's a kind of biting-the-nails type time. If we get bad [inflation] numbers, we will get a Fed tightening."

Another factor influencing Fed action will be the outcome of the budget debate, which shifts to the Senate next week. There, the tax side of President Clinton's deficit-reduction package is expected to be scaled back in favor of spending cuts. Any retreat from reducing the deficit would register strongly at the Fed.

There is a Catch-22 situation here: A retreat from deficit reduction in the budget would scare not only the Fed but also the bond market, pushing interest rates higher. That, in turn, would depress growth. But the imposition of either new taxes, which would reduce consumer spending, or cuts in government spending could also hinder economic activity.

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