Economy Get's Good News And Bad News

[gavinmccallister]

Economy gets good news and bad news
By Sue Kirchhoff, USA TODAY
WASHINGTON — U.S. corporate profits surged at the fastest pace in four years during the final months of 2005, but inflation also jumped as the nation grappled with the aftermath of Hurricane Katrina, the government said Thursday.
Businesses enjoyed a 13.8% increase in after-tax profits in the fourth quarter of 2005, a sharp rebound from the 4.3% decline in the previous quarter, the Commerce Department said. The pace of growth was the fastest since an 18.1% rise in late 2001.

In addition, a special inflation measure based on actual spending patterns, closely watched by the Federal Reserve, rose faster than expected. Commerce's index of consumer inflation, excluding food and energy, was revised to a 2.4% annual rate in the fourth quarter of 2005, from an earlier 2.1% estimate. That was far higher than the 1.4% rate of the previous quarter.

Nariman Behravesh, chief economist at Global Insight, called the report a case of good news, bad news. On the plus side, corporations are flush with cash and likely to use some of that money for capital spending. On the downside, higher inflation could be a danger sign for the Federal Reserve as it debates whether to continue raising interest rates.

Most Fed officials prefer a core inflation range of about 1% to 2%. To keep inflation in line, the Fed has been gradually raising its target for short-term rates since mid-2004 when they stood at 1%. The Fed Tuesday pushed rates to 4.75%, saying more increases were possible.

"If inflation continues to creep up, the Fed may have to hike rates more," Behravesh said. "There is a growing risk that the (Fed) may have to push rates up to 5.25% or even 5.5%."

In its report, Commerce said overall economic growth was a bit higher than previously reported in the fourth quarter of 2005. Gross domestic product, the broadest measure of the nation's goods and services, grew at a 1.7% annual pace in the fourth quarter, up from a previous 1.6% forecast.

Growth was lackluster compared with the 4.1% pace in the third quarter. Economists say, however, that the economy recovered from Katrina and Hurricane Rita in strong fashion. Global Insight pegs first-quarter growth at a 4% to 4.5% rate; others say it could be higher. Economists generally expect the economy to cool later in the year as the housing market pulls back.

In a note to clients, Moody's Economy.com noted that after-tax profits as a share of GDP surged to a record high in the fourth quarter. That could help tamp down inflationary pressures, because businesses will have more latitude to absorb higher production costs. But the firm expects profits to decline ahead as wages accelerate due to a tighter labor market. It also expects economic growth to slow to a 3% pace later this year.