The Economy Jumps; Fed Asks 'How High?'

Strong economic growth raises inflation concerns. But Fed may hold interest rates steady, watching consumers.

The United States economy keeps rolling at a rapid pace.

But consumer spending is so modest that many economists figure the Federal Reserve will keep its foot off the interest rate brake.

The Commerce Department reported yesterday that the economy grew at a torrid 3.6 percent annual rate in the second quarter. That's an upward revision of last month's estimates of 2.2 percent.

Many economists had initially expected somewhat tamer performance after the fast 4.9 percent pace set in the first three months of the year.

But the numbers may not prompt the Federal Reserve to clamp down on perceived inflation by raising interest rates.

The Fed, which meets next month to decide rate direction, "is focused on what the consumer does," says James Glassman, an economist at Chase Securities in New York, and consumer spending is modest, up at a mere 1 percent annual rate in the quarter.

Many economists now expect a slowdown in the second half, down to 2.7 percent, according to a new Fed survey of 37 forecasters. Joel Prakken, chief economist at Macroeconomic Advisers in St. Louis, Mo., forecasts growth dropping to a 2.1 percent rate after inflation

But a trigger-happy Wall Street was having none of it. Less than 90 minutes after the numbers emerged, the Dow Jones Industrial Average had plunged 125 points. (The market closed after press time.)

Stocks have been trapped in a volatile trading range the past two weeks, with daily, 100-plus point swings on the Dow becoming increasingly common.

Economists, however, are less jittery. Instead of consumer spending pushing the growth, they noted that business inventories are growing by $77.7 billion a year, the fastest advance in nearly 13 years. That's much faster than the $30 billion build-up in stocks needed to support sales.

The stock market did dip briefly last March when the Fed put down its heel to slow the economy. It boosted short-term interest rates 0.25 percentage point. But prices soon bounced to record highs.

Because inflation has behaved so well, Fed officials since then have resisted the temptation to brake the economy with another rate hike.

"[Fed Chairman] Alan Greenspan wants to be more patient," says Peter Kretzmer, an economist at NationsBank in New York.

In the April-June quarter, prices for the overall economy rose at a mere 1.5 percent annual rate, the Commerce Department said.

Good news for investors was the 7.9 percent annual growth rate of for corporate profits in the second quarter.

"That's just great," says Glassman, though it's down from 18.1 percent in the first quarter. It shows that business is keeping costs under control while giving real wage hikes to workers, he adds.

A new Fed survey of 37 forecasters found consensus for a slowdown next year, 2.5 percent compared with 3.6 percent this year.

Inflation, though, will remain well-behaved, according to the survey. Consumer prices will rise 2.3 percent in 1997 and 2.8 percent in 1998 - less than the consensus just three months ago.

US Economy: Too Hot to Handle

It grew at a 3.6 percent annual rate from April to June - versus an earlier estimate of 2.2 percent, a surprise to most economists. That means the economy neared the rapid 4.9 percent pace set in the first quarter. It also suggests higher interest rates ahead. Many economists see the economy slowing in 1997's second half, perhaps to 2.7 percent. Full-year growth last exceeded 3.6 percent in 1988.

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