Strong spending still defies economic gravity

As consumers pay more for gas, they have less available to spend on other things - a concern that showed up in last week's consumer survey.

"The head winds from higher gasoline prices and interest rates are picking up intensity," particularly for moderate income earners, writes economist Brian Bethune of Global Insight in Lexington, Mass., in an analysis for clients.

When the Federal Reserve began raising short-term interest rates in 2004, the impact on longer-term borrowing was muted at first. But recently, home mortgages have spiked.

A 30-year fixed-rate loan now carries an average 6.49 percent interest rate, up from 5.91 percent a year ago, according to Freddie Mac. Rising rates affect both new borrowers and some homeowners whose adjustable-rate mortgages are now heading up.

Again, more money for debt payments means less for other things. Sales of some retail categories such as electronic goods dropped slightly in March.

First-quarter economic growth is likely to be very strong - offsetting a slow pace of GDP at the end of 2005. But "our trend into the second quarter is not so hot," says Andrew Tilton, an economist in New York for investment house Goldman Sachs.

He has tried to model the pace of consumer "cash flow" - discretionary spending power in all US households - over the next year or more. By the end of 2006, he reckons, the pool of available cash could be shrinking moderately.

To arrive at the number, he starts with overall personal income, adds expected borrowing, and subtracts spending on taxes, debt service, energy, and food.

This doesn't mean consumer spending will fall. Many shoppers, especially those with higher incomes, find ways to keep spending even during lean times. But it does suggest some challenges ahead for the economy.

The interest rate hikes by the Federal Reserve, designed to head off a possible flare-up of inflation, creates a recipe for a pause similar to the mid-1990s.

Rate increases in 1994 were controversial, and slowed the economy sharply. But instead of triggering a recession, they set the stage for the economic expansion to continue for a full decade, until 2001.

"That's a very appropriate parallel," Mr. Tilton says. "You're trying to repeat that, but ideally not in quite as abrupt a fashion. You don't want to abruptly slow the economy and raise the risk of a recession."

In recent speeches, some Fed policymakers have hinted that their current cycle of tightening rates is nearly over. They know the policy changes already made will continue to affect the economy for months to come. "Typically you think about a one- or two-year lag," says Tilton, "for the full impact to be felt."

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