Suddenly, economy shows real verve

Consumer spending propels biggest GDP jump in 20 years, signaling a more robust recovery.

The economy now has attitude.

Consumers, flush with cash, are positively strutting, snapping up everything from jeans to Jeeps. Their confidence has spread to business, which is ordering everything from new fork lifts to wireless technology. Even US manufacturers, after years of getting kicked around by imports, are flexing their muscles abroad.

All these factors came together in the third quarter to give the US its fastest economic growth in 20 years - a spurt of 7.2 percent in the Commerce Department's first look at the third quarter gross domestic product.

But economists believe it's not just a one-shot deal. It is a turning point for what has been a lethargic economy. They believe the economy's momentum should result in economic growth closer to 4 percent over the next year. At this level, businesses will have to hire more workers. These new jobs will fuel a still stronger recovery.

"This quarter makes a case for a year ahead of above-potential growth," says Bob Gay, an economist at Commerzbank Securities in New York.

Some of this growth will continue almost immediately into the fourth quarter. Business has run down inventories and now has to replace them to keep up with their accelerated sales rate. "When they start restocking, it will be a further boost to the growth curve," says Tom Duesterberg, president of the Manufacturers Alliance/MAPI, a business group.

Inventories have dropped, in large part, because consumers have gone on a spending spree. Last quarter, many Americans received child tax credits and saw their income tax withholding rates fall.

At the same time, many people refinanced their houses and enjoyed lower monthly payments. "The consumer is stronger than anyone thought," says John Silvia, chief economist at Wachovia Securities in Charlotte, N.C.

Interest rates will likely stay same

Even though the economy is sizzling, economists don't expect to see any immediate changes in Federal Reserve policy. The Fed met this week and kept interest rates unchanged. In its statement, it said the labor market appeared to be stabilizing but saw no signs of inflation.

"The economy is a lot stronger than the Fed indicated and that tells us the Fed is lagging," says Sung Won Sohn, chief economist at Wells Fargo Banks in Minneapolis. "Inflation expectation, along with actual inflation, is on its way up."

The last time the economy grew at this rate was in the first quarter of 1984 after the Kemp-Roth tax cuts. "There are some similarities," says Mr. Sohn. "The next recession was not until 1992 so we had almost a decade of prosperity."

The stronger economy could have a major impact on corporate profitability. Thursday, reflecting the new vitality in the economy, Citigroup Securities raised its estimate of corporate earnings growth to 15 percent this year and 12 percent next year.

With profits rising, business is finally starting to spend. In the third quarter, business investment on equipment and software grew by 15.4 percent - compared with 8.3 percent in the prior quarter. "This indicates the missing link, business investment, has materialized," says Mr. Duesterberg.

Two major factors are helping business. As company balance sheets have improved, banks are now more willing to make loans, says David Heuther, chief economist at the National Association of Manufacturers. Bankers had tightened standards when the economy was struggling last year.

Moreover, overseas growth is starting to pickup at a time when the US dollar is lower in value. "This means some other part of the world will help shoulder the burden of being the engine of global growth," says Mr. Gay.

Although economists expect consumers to slow down their spending in the current quarter, retailers are still reporting strong sales. Partly, this is due to the weather. A cool spring and a wet start to the summer cut into purchases of warm-weather clothing. But starting in July and continuing through October, thermometers were closer to normal.

This helped put consumers into more of a buying mood as evidenced by such stores as the GAP, which saw sales increase 14 percent in September compared to the prior year. The hot items this fall: corduroy low risers for women, five-pocket "laid back" jeans for men, and layering of all sorts. Later this week, GAP will reveal October sales.

Brisk sales of ice cream

Consumer yearnings were diverse. For example, Graeter's Ice Cream in Cincinnati, Ohio, had a booming third quarter. In July, the company sold 100 to 120 gallons a day of peach ice cream. In August, consumers were choosing coconut and in September it was cookie dough chip. "I think people were ready to spend," says Tom Kunzelman, director of operations.

Mr. Kunzelman thinks the spending will continue as people start to buy ice cream - a discretionary item - for the holidays. In anticipation of the higher order flow, the company decided not to lay off any employees even though the big ice cream season is over.

"There are times when even working mandatory overtime and Saturdays, it's a challenge to keep up," he says. "Christmas could be kind of scary."

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