Originally created 04/02/97

Reports confirm economy growing, but price inflation under control



NEW YORK - Economic reports released Tuesday confirmed the economy remains strong, reinforcing investors' fears that short-term interest rates will continue to rise.

In three separate reports, a widely followed gauge of manufacturing activity showed American businesses expanded in March, the government's key indicator of future economic activity recorded its biggest jump in a year, and construction spending posted its largest gain in 11 months.

The reports suggested that inflation may be looming. They provided little comfort to economists and investors hoping last week's interest-rate tightening by the Federal Reserve might be its last for a while.

"These reports continue to confirm a lot of the strength we've seen in the numbers that have come out recently," said Anthony Chan, vice president and chief economist at Banc One Investment Advisors in Columbus, Ohio.

Investors weren't quite sure what to do with the news.

Bond prices backed off a little but then started climbing. Investors seized on a drop in the prices-paid component of the manufacturing report from the National Association of Purchasing Management as a signal that inflation isn't about to flare up.

Stock prices swung widely in morning trading but settled into slightly positive territory in early afternoon.

The 30-year benchmark Treasury bond was down 13-32 point. Its yield, which moves in the opposite direction, moved up to 7.08 percent. The Dow Jones industrial average was up 30 points near the close at 6,613.69, recouping just 10 percent of the nearly 300-point loss that it suffered in the previous two sessions.

That downdraft in the Dow followed last week's move by the Federal Reserve to increase its target for the federal funds rate, which banks charge each other on overnight loans, by a quarter percentage point, to 5.5 percent.

Tuesday's three reports fueled concerns that inflation is a big enough problem to prompt the Federal Reserve to raise interest rates again.

On Tuesday, the NAPM said its index of economic activity rose to a two-year high of 55 percent in March from 53.1 percent in February, exceeding economists' expectations by a full percentage point.

"This means this growth is not dangerous," Chan said. "It's not going to cause extreme price pressures, so the Fed doesn't have to act so aggressively" to boost interest rates.

But, Chan cautioned, when Fed policymakers announced their action last week, chairman Alan Greenspan indicated he was watching not just price movements, but also changes in the amount of consumer demand to try to anticipate the direction of inflation.

The demand picture was not encouraging. The report also showed healthy gains in new orders and backlogged orders, as well as employment, indicating that strong demand is spurring manufacturers to keep churning out goods.

Separately, the Conference Board, a private business research group in New York, said its index of leading economic indicators rose 0.5 percent in February, to 103.5. Economic forecasts had called for an increase of between 0.2 percent and 0.4 percent.

Nine of the 10 indicators measured by the index pointed to growth. The biggest change among the components came in the average weekly claims for unemployment insurance. That signaled to economists and investors that Friday's job-growth and unemployment data for March might be strong and further fuel a Fed tightening.

Finally, the Commerce Department said construction spending shot up 2.3 percent in February, the biggest gain in 11 months. But Anthony Chan, vice president and chief economist at Banc One Investment Advisors in Columbus, Ohio, shrugged off the potentially inflationary implications of that report, saying unseasonably warm weather "boosted this number up big-time."

Lynn Reaser, chief economist at Barnett Banks Inc. in Jacksonville, Fla., disagreed that Tuesday's reports would prompt the Fed to tighten more.

Reaser said the Fed's bottom-line concern about inflation was eased by slower growth in manufacturers' prices. In addition, bond investors have already pushed interest rates higher in the open market, and that factor, plus last week's official tightening, had to be given time to work before the Fed stepped in again.

"Time will be required to allow those forces to affect the economy. As a result, a near-term or even future increase in interest rates by the Fed is very much open to question."

And David Hale, chief economist at Kemper Securities in Chicago, said the NAPM index at 55 percent isn't anywhere close to forcing the Fed's hand.

"If we can keep the index around 50," he said, "even though output is strong, that doesn't rule out more tightening but it means it will be more gradual."