Potent signs of inflation emerged with reports Thursday that the biggest jump in consumer spending since 1983 sent economic growth soaring in the last quarter while labor costs accelerated to a 10-year high.
Analysts said the reports of an 8.3 percent surge in spending, combined with a 4.3 percent leap in labor costs, would provoke more vigorous action by the Federal Reserve in coming months to slow the speeding economy with sharply higher interest rates.
While growth appeared to slow some to 5.4 percent in the winter quarter from a heady 7.3 percent rate at the end of 1999, analysts said various components of the Commerce Department’s gross domestic product report showed that underlying spending by U.S. consumers and businesses actually increased.
Consumers voraciously bought cars, appliances and other big-ticket goods at a stunning 27 percent pace, while businesses increased spending on computers and other equipment and investments by a sizzling 21 percent.
The spending splurge extended to an array of imports, causing the trade deficit to bulge to a breathtaking $377 billion. That posed a drag on domestic growth that ironically was a main reason for the slowdown during the quarter.
At the same time, a more than doubling of increases in the cost of health care to 7.6 percent over the last year helped drive a 50 percent jump in labor costs for private employers, the Labor Department reported.
“Hold onto your hats,” said Joel Naroff, president of Naroff Economic Advisers in Holland, Pa. Fed Chairman Alan Greenspan’s “nightmare is beginning to come true,” he said.
“The rebound in benefits is startling,” he said, and suggests that medical-cost inflation has come back to stay.
The Fed will be astonished that “the consumer is out of control and the economy continues to surge ahead” despite five quarter-point interest rate increases by the central bank in the last year, he said.
“Retailers could barely restock their shelves” in their efforts “to feed the consumer monster,” he said, while “state and local governments did their part in spending every penny of the surpluses.”
Only the Pentagon “lost its checkbook” temporarily, he said.
Mr. Naroff said the Fed might raise interest rates by as much as a half point at a May 16 meeting of its rate-setting committee. “Hopefully, the markets will accept that as necessary to keep the expansion going and not get bent out of shape too badly.”
The stock market sold off on the inflation news at the beginning of trading Thursday, but by day’s end had recouped most losses as a powerful rally in battered technology stocks bolstered the market.
After initially plunging more than 100 points, the Nasdaq Composite Index came back to end the day up 145 points at 3,774. The stocks of financial companies got pounded, driving the Dow Jones Industrial Average down as much as 197 points, but it mostly recovered to end down 57 at 10,888.
David Jones, a noted Fed-watcher with Aubrey G. Lanston & Co. in New York, said the markets are not prepared for the aggressive action the Fed is likely to take in response to the “red flag” of sharply higher labor costs seen in Thursday’s report.
The Fed is likely to raise rates by another point by August, although it will continue to move in quarter-point increments to avoid jostling the markets too much, he said.
Mr. Greenspan’s job of slowing growth and deflating the market bubble without causing a crash “is as delicate a challenge as he’s had as Fed chairman,” he said. “How do you let a little air out of a balloon? It’s a risky proposition.”
Still, the Fed is compelled to act, despite the pressure of election-year politics, because “the overheated economy, if anything, is accelerating this year,” Mr. Jones said.
“It’s no longer just the threat of inflation, but the reality of higher wage and cost pressures that will be the driving forces of Fed policy.”
The Fed will be particularly worried about the pickup in medical costs, he said, since Fed members repeatedly have pointed out that declining medical costs due to the managed care revolution of the 1990s were a major reason for the slowdown in inflation that kept the Fed on the sidelines.
“Now, we’re seeing a sharp reversal,” and that comes on top of “widespread price increases” in consumer staples from housing to air fares shown in a March consumer price report released earlier this month, Mr. Jones said.
Some economists held out hope that a surge in worker productivity during the quarter justified the jump in labor costs, and will mitigate the inflation threat.
“Productivity-led growth is not inflationary,” said Ed Yardeni, chief economist with Deutsche Banc Alex. Brown. During the second half of 1999, he noted, productivity accounted for almost all of the economy’s stellar growth.