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U.S.: Will Growth Cool Off Enough To Chill Inflation Fears?

Business Outlook: U.S. ECONOMY


Don't look for a repeat of last quarter's boost from trade

Wall Street rarely works itself into a lather worrying about gross domestic product. It's considered old news, since the monthly data already give analysts a good idea of how the components will add up, and it's thought to hold little insight into the future. Even so, the Commerce Dept.'s report on fourth-quarter GDP, due on Jan. 31, might well spark more than the usual amount of discussion--and market reaction.

That's because economic growth last quarter appears to have accelerated to an annual rate in the neighborhood of 4%, up from 2.1% in the third quarter. Only a few weeks ago, it was widely expected that growth last quarter would remain at about 2%. Growth at 4% is sure to raise questions about future inflation and Federal Reserve policy, especially with other indicators, notably in the manufacturing sector, suggesting that the economy was gathering momentum as it began 1997.

Several Fed policymakers recently have spoken more pointedly about concerns over future inflation in the face of strong growth and an already tight labor market. Of course, the most important policymaker, Fed Chairman Alan Greenspan, offered little in his Jan. 21 congressional testimony to suggest that he is ready to lift interest rates, but he too spoke warily of growing wage pressures. Even the Fed's Beige Book, a report on regional conditions, noted that economic growth remained "moderate," but shortages of skilled labor were lifting wages in some areas.

THE KEY QUESTION IS, will the economy's rapid fourth-quarter pace continue? Measured by top-line GDP growth alone, the answer is probably not. That's because a big swing in the trade deficit accounted for much of last quarter's acceleration (chart), and that lift will not be repeated this quarter. However, the latest monthly data strongly imply that domestic demand and production are gaining steam. If so, labor markets will tighten further, and producers will edge ever closer to the limits of their production capacity.

So here's a roundup of what to expect from the upcoming report on fourth-quarter GDP and what it means for the economy as 1997 gets under way:

In addition to foreign trade, a rebound in consumer spending and an explosion in business construction supplied the economy's power last quarter. Business investment in equipment grew at a much slower pace, and housing barely advanced. Inventories appear to have risen a bit more slowly than they did in the third quarter, providing about the only drag on growth.

The turnaround in foreign trade was stunning. Exports surged broadly last quarter, while imports barely rose. As a result, net exports likely added some two percentage points to real GDP growth. The monthly data show that the trade gap for goods and services edged up to $8.4 billion in November, from $8 billion in October, but the deficit had averaged $11.2 billion per month in the third quarter.

The improvement is part real and part illusion, however. In recent years, the trade gap has shown a tendency to narrow in the fourth quarter only to widen again in the following quarter, probably reflecting inadequate seasonal adjustment. But while last quarter's export surge, at an estimated 15% to 20% rate, is not sustainable, other signs--such as firmer growth abroad, stronger export orders, and the pickup in factory output--hint that export growth is improving again after slowing down during much of last year.

Of course, with imports still grabbing an increasing share of U.S. demand, they are not likely to remain flat in the first quarter. All this means that trade should be a drag on first-quarter GDP--but for the year, it will most likely end up being a small plus.

ANOTHER BIG BOOST last quarter came from business construction, although here, too, don't expect first-quarter growth to match that double-digit surge. Still, the upturn in commercial building seems lasting. Office vacancy rates have fallen, especially in suburban areas. Hotel rooms are in short supply in many cities. And lending conditions are favorable.

Residential construction is a different story (chart). Housing starts dropped 12.2% in December, to an annual rate of 1.33 million, but extremely harsh weather in the West accounted for the region's 29.2% plunge. Permits to begin new construction held up fairly well, however, even in the West. That suggests a rebound when the weather improves.

Last quarter's surge in business construction offset some of the expected slowdown in business equipment. Outlays for equipment appear to have slowed to a low single-digit pace after rising at a 20% annual rate in the third quarter. However, the third-quarter pace was inflated by a surge in aircraft purchases, which eased in the fourth quarter. The true trend lies somewhere in between, and it should reassert itself in the first quarter, given good profit growth and continued strength in high-tech spending.

The final source of strength last quarter, and the most important, is consumer spending. Consumers proved that their weak third-quarter showing was only a breather. Growth appears to have rebounded to about 3%, from only 0.5% in the third quarter. Given strong labor markets, consumers seem likely to keep spending at least in line with an expected rise of 2.5% to 3% in real disposable income, providing a key support for economic growth in early 1997.

ONE OF THE MOST IMPORTANT SIGNS of the economy's forward drive is the ongoing pickup in manufacturing. Most recently, overall industrial production rose a solid 0.8% in December, the same as in November. But excluding a weather-related weakness in December utility output, factory production jumped 1.1% and posted the strongest two-month gain since 1994.

Last year's ups and downs in auto production, especially the strike-related drop last quarter, have obscured a broad acceleration in manufacturing output. Excluding motor vehicles and parts, output has grown faster in each of the past four quarters (chart). The high level of overtime and rising orders outside of the auto industry at the end of 1996 suggest that manufacturing's momentum carried into 1997.

Moreover, auto and truck production are scheduled to bounce back strongly in the first quarter. With auto makers ending 1996 with stocks of motor vehicles at comfortable levels, some of the increased production may be held in inventory. That means rising inventories could be a small plus for first-quarter GDP growth, after last quarter's likely drag.

Add it all up, and first-quarter GDP growth seems destined to fall back to a moderate pace in the 2%-to- 3% range. But with factory production starting to rise faster than new capacity and with tight labor markets already pushing up wages, a tamer-looking GDP number may not be enough to placate the Fed.By JAMES C. COOPER & KATHLEEN MADIGANReturn to top

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