Economic Numbers Carry Ominous Inflation Signals

Wages and benefits for U.S. workers rose at the fastest pace in 10 years during the first quarter, stoking the spending habits of American workers as the overall economy grew at a robust pace, the government reported Thursday.

Newly released economic data also pointed to an accelerated rise in consumer prices, in part driven by oil, that is likely to intensify inflationary fears in Washington and on Wall Street.

Gross domestic product, a broad measure of U.S. economic growth, pushed ahead at a 5.4% annualized pace in the first quarter, the Commerce Department reported. That is slower than the 6.0% economists had expected, but still a sure sign that the economy, going into its record 111th month of expansion, continues to surge far above historical trends. The report's measure of consumer prices, the personal consumption expenditures index, accelerated sharply to a 3.2% annual pace, from 2.5% in the fourth quarter.

The economy grew at a 7.3% annual pace in the fourth quarter of 1999, and at a 4.1% overall pace in 1999.

A separate report on employee compensation from the Labor Department also had inflationary implications. The employment cost index, a measure of growth in wages and benefits for U.S. workers, grew at a larger-than-expected 1.4% pace in the first quarter, the fastest rate since 1990. Economists had been looking for the ECI to grow at a 0.9% pace.

While the data point to continued signs of a robust U.S. economy, they also showed rising inflationary pressures, which raised expectations that the Federal Reserve might intensify its campaign to raise interest rates in an attempt to cool the relentless pace of growth.

The ECI report indicated that as unemployment sits near historical lows at 4.1%, employers face more difficulty retaining workers and must raise salaries and benefits to keep desired employees. Economists fear that as businesses have to deal with rising employee costs, they will eventually have to pass the added burden onto customers in the form of higher prices.

The effect of higher wages, along with a broadly employed population and wealth created by stock markets, have all pushed U.S. consumers, who account for about two-thirds of total economic growth, to keep spending at a feverish pace. That could also prove inflationary as a growing number of dollars chases the same amount of goods and services.

"There is no doubt that these numbers show that inflationary pressures are starting to intensify and that the economy has not meaningfully slowed," said Richard Rippe, chief economist at Prudential Securities in New York. "There was an effect from the rise we saw in oil prices, but overall we are still seeing signs that inflation is starting to take hold in the system." Excluding volatile energy prices, the personal consumption expenditures index in the GDP report grew at a tamer 1.8% pace.

Another inflation measure in the GDP report, the gross domestic purchase index, accelerated to a 3.2% pace in the first quarter, compared with a 2.3% pace in the fourth quarter of 1999. The Commerce Department pointed out that a large part of the acceleration reflected a pay raise for government and military employees and the rise in energy prices. Excluding energy, the purchase index rose at a 2.1% rate, compared with 1.9% in the fourth quarter.

Consistent with other trends in the current economic expansion, consumer spending was the primary engine behind growth and partly responsible for the uptick in inflation. Spending rose at an 8.3% annual rate in the first quarter, its highest level since the 8.6% pace in the second quarter of 1983, when the country was recovering from a recession.

"The average consumer is spending like a millionaire. This will be very problematic for the Fed, as they want consumer spending to slow," said Mary Ann Hurley, market strategist at D.A. Davidson & Co. in Great Falls, Mont.

In an attempt to curb demand and slow overall economic growth, the Federal Reserve has raised its benchmark overnight lending rates five times, in 0.25-percentage-point increments, since last June. In theory, higher interest rates serve to slow economic growth by making it harder for consumers and businesses to borrow and spend.

But even though the increases have affected everything from mortgages to car loans to credit card rates, consumers and businesses have shown little reaction. Fueled by higher wages, stock market gains and a rebound in overseas demand, consumers and businesses have remained extremely confident and continued to spend freely.

Many economists expect that the seemingly endless signs of economic strength could push Federal Reserve officials to intensify their efforts to slow the economy, perhaps in the form of higher magnitude rate increases of 0.50 percentage points or more. Fed policymakers are next scheduled to meet May 16, and are widely expected to raise rates to some degree.

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