Sizzling economy may spark rate boost

Domestic product soars, triggering inflation concerns

February 26, 2000|By William Patalon III | William Patalon III,SUN STAFF

The U.S. economy grew at its fastest clip in 3 1/2 years during the final three months of last year, further evidence that the Federal Reserve Board will raise interest rates still higher to chill the sizzling expansion and stave off inflation.

The gross domestic product -- the sum of goods and services produced -- surged at a 6.9 percent annual pace in the fourth quarter last year, the Commerce Department said yesterday. That was up from the original estimate of 5.8 percent and is the strongest quarter of growth since a similar rate was recorded in the second quarter of 1996.

Blue-chip stocks extended their swoon on the news, amid investors' worries about interest rates. The Dow Jones industrial average fell 230.51 points, or 2.28 percent, while the broader Standard & Poor's 500 index dropped 20.07 points, or 1.48 percent, to close at 1333.36.

Technology stocks weren't immune to fears of more interest rate increases. The Nasdaq composite index fell 27.16 percent, or 0.59 percent, to end the week at 4,590.49.

"From the point of view of the Federal Reserve, it basically confirms that growth is too strong," said David Orr, chief economist for First Union Corp. in Charlotte, N.C. "This gives them some maneuvering room and some political cover and gives critics [of a tight credit policy] less room to maneuver. It provides more credibility for the Federal Reserve's stance. Nobody's going to argue that 7 percent growth is sustainable."

For the Fed, under Chairman Alan Greenspan, achieving "maximum sustainable growth" has been a mantra. The central bank wants healthy growth, but not growth frenetic enough to spark inflation or lead to the extreme -- and typically harmful -- boom-and-bust cycles economies worldwide have been experiencing for generations.

The central bank's policy-making arm, the Federal Open Market Committee (FOMC), has raised short-term interest rates four times since late June.

Need for vigilance

Greenspan has consistently pointed to the need to be vigilant against inflation as a key reason behind his strategy, though more recently he has expressed worries that the demand for goods and services from consumers might far outstrip supply, which also would lead to inflation.

Yesterday's revised GDP was led by personal and government spending that was higher than had been estimated.

Consumer spending, which traditionally accounts for two-thirds of the nation's economic activity, rose at a 5.9 percent annual pace during the fourth quarter of last year, more than the 5.3 percent the government initially estimated.

Government spending increased at a revised 9.2 percent annual clip in the last three months of the year, the fastest rate of increase since the third quarter of 1986.

Economists said that probably reflected government efforts to avoid computer problems related to fears of a year 2000 computer problem.

Uncertainty about impact

Raising interest rates slows the economy by making it harder for businesses and consumers to borrow money to spend on big-ticket items.

Though the rate increases should have an impact, it's not clear that they have.

Orders for durable goods -- large items ranging from washing machines to aircraft that traditionally are sensitive to higher interest rates -- fell 1.3 percent last month after rising 6.3 percent in December, which was the largest gain in seven years, the Commerce Department said yesterday.

Orders for commercial aircraft fell 2 percent last month, dragging down the overall total.

But orders for business equipment, such as computers and machine tools, rose 12.3 percent, the largest one-month increase since February 1985.

"Manufacturing is healthy," said Greg Jones, chief economist with Briefing.com in Jackson, Wyo. "We're really not seeing much evidence that higher interest rates have slowed manufacturing."

For now, however, it appears that the more costly loans caused by higher interest rates are pressuring the housing market. Sales of existing single-family homes fell 10.7 percent last month -- the largest decline in almost five years -- to an annual rate of 4.59 million, the National Association of Realtors reported yesterday.

That drop, which exceeded the 1.4 percent decline predicted by economists, was the largest since a 12.5 percent decline in April 1995.

Key issues

How much the economy slows, and how quickly, are key issues that will determine how many more times the Greenspan-led FOMC will boost short-term interest rates.

"The economy was smoking during the fourth quarter, [and Greenspan] is determined to extinguish this blaze before it develops into a five-alarm fire," said Richard Yamarone, an economist with Argus Research Corp. in New York City. "Look for two additional 25 basis point [quarter point] rate hikes by midyear."

Mark Zandi, chief economist for RFA Dismal Sciences in West Chester, Pa., said the Fed could raise rates by a half-percentage point to 1 percentage point before the end of summer.

"The economy is busting out all over," he said.

Bloomberg News contributed to this article.

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