- The Washington Times - Wednesday, January 31, 2007

The economy bounced back at the end of last year, growing at a surprisingly strong 3.5 percent rate, after a steep drop in gasoline prices revived consumer purchasing power and spurred a Christmas spending spree.

A report from the Commerce Department yesterday showed that consumers defied expectations and powered a solid performance in the economy all year, shrugging off not only the summer’s record-high energy prices but also a collapse in the housing market and sharply higher interest rates. Despite the obstacles, economic growth during the year ticked up to 3.4 percent from a 3.2 percent pace in 2005.

But incomes did not keep up with spending, despite solid growth in jobs during the year, forcing consumers to go deeply into debt and dip into their savings to maintain a robust spending pace. The result was that the savings rate for the year plummeted into negative territory at minus 1 percent — something not seen since the Great Depression.

“There’s nothing stronger than a fully employed American consumer,” said Argus Research economist Richard Yamarone, noting the “blistering” 4.4 percent pace of fourth quarter spending startled many on Wall Street. “It’s not the value of a home or the level of the stock market, but employment that drives consumer spending and the economy.”

Stocks rallied on the unexpectedly strong economic performance and low inflation seen in the Commerce Department report, which appeared to please the Federal Reserve and enabled the central bank to keep interest rates steady at a meeting of its rate-setting committee yesterday.

The record drop in oil prices during the quarter not only bolstered consumer spending but also caused a rare drop in the value of imports, further boosting growth.

“The economy has clearly caught its second wind,” said Bernard Baumohl, managing director of the Economic Outlook Group, an economic advisory firm in Princeton Junction, N.J. “After six months of below-trend growth, the combination of higher real wages, low unemployment and the drop in energy prices ignited the economy’s engines once again.

“What’s really remarkable about the economy’s performance last year is that it successfully dodged so many bullets,” he said, attributing that to the flexibility of American consumers, workers and financial markets. “Most other economies in the world would have gone belly up” in the face of the same obstacles.

The Fed said in its statement that stronger growth and tightness in the labor market require it to maintain vigilance against a possible uptick in inflation. But yesterday’s growth report put to rest months of rumors on Wall Street that the Fed’s next move would be to cut rates amid mounting worries about weakness in the housing market — weakness that had been expected to spread to consumer spending.

To the contrary, the report showed above-average growth despite a 19 percent drop in home construction in the fourth quarter — the second such major decline in the once-booming housing market and the biggest losses in 15 years.

The Fed noted “tentative signs of stabilization” in housing, most likely referring to a report from the Mortgage Bankers Association yesterday that showed a small pickup in mortgage applications for home purchases from year-ago levels. Housing continues to benefit from relatively low long-term mortgage rates, which are not directly set by the Fed.

Roger M. Kubarych, economist at UniCredit Markets, said he does not expect a repeat of last quarter’s stellar economic performance. Consumers benefited not only from falling oil prices but also from aggressive pre-Christmas price discounting on big-ticket items such as autos and electronics, whose prices fell at a record 8 percent rate, he said.

“That kind of price collapse is not going to be repeated,” he said, “nor is the pace of consumption going to be sustained.”

Richard Berner, economist at Morgan Stanley, also questioned whether the decline in inflation will last. He said that unusually warm weather may have prompted stronger than normal economic activity this winter and if weather was the stimulant, there will be a “payback” in the form of slower growth in the spring.

Mr. Yamarone said he expects growth to remain impressive in the first quarter because jobs remain plentiful and energy prices have stayed low due to the mild winter.

The danger is that inflation will remain a problem as well, he said, since stronger-than-expected growth in the United States will contribute to pressure on world commodity prices. In addition, the U.S. is likely to suffer from a homegrown problem — soaring food prices brought on by a shortage of corn for making oil, sweeteners and other common food ingredients as farmers increasingly devote their corn crops to making ethanol.

“We’ve heard from several companies like Kellogg, General Mills, Tyson Foods, Procter & Gamble and Pepsi about price pass-alongs, and we expect many more to join in,” Mr. Yamarone said. A 60 percent jump in corn tortilla prices already has produced a minor crisis in Mexico, which imports much of its corn from the U.S.

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