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Cloud Call Center Community Featured Article

[November 05, 2006]

USA economy: What next?

(EIU Viewswire Via Thomson Dialog NewsEdge) COUNTRY BRIEFING

FROM THE ECONOMIST INTELLIGENCE UNIT

Is the ever-resilient US economy shrugging off the collapse in the housing market?

New jobs figures from the government on November 3rd showed stronger employment growth in the last three months than anyone expected. George Bush and his embattled Republicans wasted no time flaunting the numbers at campaign stops as they try to head off a rout in congressional elections on Tuesday.

The new jobs figures, in fact, dont change the outlook for the economy much. The Economist Intelligence Unit has always expected a big slowdown in economic growth in 2007 and we still do. But we were never among those who were forecasting a recession, and the relatively buoyant labour market supports our view that enough people will stay employed to keep incomes up and consumers spending at a reasonable pace.

The US economy created 92,000 new jobs in October, less than the consensus forecast of around 123,000. But the government revised up total new job growth in the two prior months by a substantial 139,000, which brought the average for the last three months to 163,000about where it has been for the last couple of years and consistent with good economic growth. The unemployment rate also improved, to 4.4% from 4.6%, and is now at the lowest level in more than five years. An impressive performanceand a potentially puzzling onefor an economy that grew by a paltry 1.6% in the third quarter.

Part of the explanation is that the labour market is a lagging indicator: employers lay off staff, and defer hiring, only after business slowsand the economy has just begun to fade. The jobs market will almost certainly weaken over the next 12 months as economic growth retreats from an estimated 3.3% this year to around 2% in 2007. But with the labour force growing at a slower pacebecause fewer teenagers and women are entering the labour pool and retirees are exiting soonerthe number of available workers will be smaller than it otherwise might have been, placing some upward pressure on wage inflation.

Inflation pressures

Indeed, the big news in the jobs report, and in earlier figures on productivity and wages, is that inflation pressures may not be quite as tame as most analysts expected. The labour market is looking stretched, and hourly earnings in October rose 0.4% from the prior month and by 3.9% from the year before, near the upper end of whats considered acceptable. The Fed wont like any of this, and will be less likely to cut interest rates, even if the economy is slowing a lot.

That explains why financial markets reacted so badly to the jobs report. With inflation suddenly looking perkier, bond prices plunged and the yield on the 10-year US Treasury note rose 12 basis points, the biggest jump in more than three years.

The US economy, as we have argued for some months now, is in a transitional stage. Although clearly slowing, in part because of less investment in housing and falling home prices, the economy hasnt lost all of its momentum. Wages were slow to rise when the economic recovery from the last recession began, and compensation is still rising as it catches up, at least in part, with corporate profits and past inflation. Higher incomes, therefore, may keep consumers from cutting spending too much. Generally low interest ratesmoney-market rates are still comfortably below 5%will keep credit conditions from hurting borrowers too much. Lower oil prices and a reasonably strong stock market are also helping to offset the shock from weak home prices, which have fallen for two straight months.

Difficult job for the Fed

All of this makes the Feds job especially difficult. After raising its benchmark interest rate at 17 straight meetings starting in June 2004, the Fed has held the rate steady for the last three months as the economy has slowed. Indeed, financial marketsand the Economist Intelligence Unitexpected the Feds next move to be an interest rate cut next year. We still believe the Fed will trim rates in 2007: inflation, though higher than the central bank would like, is not accelerating, and with the economy likely to grow by 2% or less at an annual rate for another few quarters, a monetary boost still seems likely. At its last interest-rate meeting, the central bank said prices pressures should moderate over time as the economy slows.

While that remains our view as well, figures released a day before the jobs report give pause. Productivity in the third quarter was stagnant, and labour costs in the 12 months to September rose by 5.3%, the largest gain since 1982. Productivity almost always falls off as the economy slows, but if the pull back is too large and doesnt offset wage gains, inflation fears will accelerate. Labour expenses comprise about two-thirds of the cost of producing a product or service.

While the outlook for the economy is more unsettled after the recent government reports, a few things havent changed. Investment in housing has plungedit fell 17.4%at an annual rate in the third quarter, the biggest decline since the first quarter of 1991, when the economy was struggling to emerge from recession. With so many unsold homes on the market, construction wont accelerate any time soon, holding back the economy. If home prices keep falling, and they probably will for a while, consumer spending will also remain under pressure as people borrow less against the value of their property. All of this spells a slower-growing economy. The big question is whether inflation retreats along with it. Lower oil and commodity prices will certainly help, and wage pressures should eventually ebb. But if they dont, policymakers will be faced with their biggest dilemma in years.

SOURCE: ViewsWire New York

Copyright 2006 Economist Intelligence Unit

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