By Sue Kirchhoff, USA TODAY
WASHINGTON — The economy appears to be firming, with strong retail sales, steady expansion in manufacturing and the service sector, and rising employment — making it more likely the Federal Reserve will keep raising interest rates well into the spring or early summer, economists say.
But while the recent numbers indicate solid growth in the first quarter of 2006, some analysts expect activity to cool later in the year, due partly to a slowing housing market. The uneven outlook complicates life for new Fed Chairman Ben Bernanke, who must weigh the possibility that rising wages, slowing productivity and a tight job market will breed inflation against the possibility of slower growth down the line.
"Now the tough decisions arrive," says Ethan Harris of Lehman Bros., which Friday raised its forecast for first-quarter economic growth to a robust 4.8% from an earlier estimate of 4%. By comparison, the economy grew at a slow 1.1% rate at the end of 2005.
"Our feeling is that because you have a new central banker, they are going to want to err on the side of restraint against inflation," says Harris, who expects economic growth to cool later this year.
Wells Fargo raised its projection for Fed interest rate moves on Friday, based on recent economic data. Wells Fargo now expects the Fed to increase interest rates in quarter-point increments at both its scheduled March and May meetings. That would take rates to 5% from the current 4.5%.
"There are lots of indicators that show that the economy has accelerated considerably in the first quarter," says Eugenio Aleman, Wells Fargo senior economist.
"This doesn't mean that it will remain so strong in the next couple of quarters, but the Federal Reserve cannot sit down and look and wait, because whatever they do today, it takes effect in six to 12 months," Aleman says.
The Labor Department on Friday said business payrolls expanded by 193,000 in January and the unemployment rate dipped from 4.9% to 4.7%, the lowest since mid-2001. Employment was up in a variety of industries, including construction and health care.
Hourly earnings rose 0.4% in January and are up 3.6% in the past 12 months. However, hours worked remained flat.
While hourly wage gains are good news for workers, they can be a warning sign to the Fed of inflation pressures. The wage gains follow a report that productivity, or output per worker, fell at the end of 2005. High productivity also helps keep wage pressures in check.
Also Friday, the private Institute for Supply Management said the service sector expanded at a slower, but still healthy, pace in January.
Not all economists see the economy as forcing more Fed moves.
"Given the absence of core inflation, it seems to me as good a time as any to pause and see what's happening for a few months rather than overshoot and risk a recession," says Bill Cheney, chief economist at John Hancock Financial Services.