Home Sales, Inventories Suggest Rebound But Growing Economic Strength Holds Specter Of Rate Hike

Higher-than-expected new home sales in April, amid signs that businesses are poised to beef up depleted inventories, point toward faster economic growth this summer.

That revives concerns that the Federal Reserve may have to raise interest rates at a July policy meeting to keep growth from heating up inflation.

“We’re going to get very strong second-quarter economic growth, and it does mean the Fed may have to tighten sometime this summer” by raising rates, said Michael Strauss, chief economist at Yamaichi International (America).

Two government reports Thursday added fuel to the debate about whether the economy is overheating. Sales of new homes, a key barometer of consumer demand, increased 6.7 percent during April, the Commerce Department said. Separately, the department estimated the economy grew at a 2.3 percent annual rate during the first quarter, slower than previously reported, as businesses shrank their stockpiles of unsold goods for the first time in four years.

That could point to faster growth as companies restock, adding to inflation concerns that are leading bond traders to push yields higher without waiting for the Fed to act.

Bond prices fell for the third day in a row, with the benchmark 30-year U.S. Treasury bond down as much as 1/2 in midday trading, pushing its yield up more than 3 basis points to 6.97 percent. Bonds later erased their losses after the Treasury reported it had sold $12.5 billion in 5-year notes at a lower-than-expected yield. Stocks, meanwhile, were higher, while the dollar was lower against other major foreign currencies.

The yield on the Treasury’s 30-year bond is now a full percentage point higher than at the start of the year. Back then, there were concerns that a slowdown could lead to a recession. Now, comments by Federal Reserve officials suggest that they are worried about the threat of accelerating inflation that often accompanies faster growth.

Fed Gov. Susan Phillips Wednesday described the economic recovery as being on a “solid track,” and Alfred Broaddus, president of the Federal Reserve Bank of Richmond, raised concerns that the economy could be growing faster than the Fed’s non-inflationary target of 2 percent. In the current second quarter, the economy may be growing at close to a 3 percent annual rate, analysts said.

The Commerce Department’s estimate of first quarter growth in the gross domestic product - the total output of goods and services - is down from an initial estimate four weeks ago of a 2.8 percent growth rate for quarter. Still, it’s better than last year’s fourth-quarter growth rate of 0.5 percent and confirms the economy is on the rebound. “We’ve got momentum in business and consumer spending,” said Scott Brown, an economist at Raymond James & Associates in St. Petersburg, Florida.

That was shown by the report’s statistics on real final sales, which exclude the effects of shrinking inventories. Real final sales grew 3.7 percent in the first quarter, the largest gain since the third quarter of 1994, and up from the initial estimate of a 3.3 percent increase.

To be sure, many businesses will be slow to beef up inventories in case consumer spending fades. “Firms are still somewhat cautious after having been burned in late ‘94 and early ‘95” when spending faltered, said Brown.

More confirmation of a rebounding economy came in the statistics on new home sales, which showed the third monthly increase this year, even in the face of rising mortgage rates. Sales of previously owned homes, too, continued to grow in April, reaching the second highest level on record, an industry group reported earlier this week.

Rising mortgage rates may be partially responsible for the strong home sales figures, as home buyers who have been sitting on the fence jump to lock in rates before they go up much further.

“The housing sector has been extremely resilient,” said Bruce Steinberg, an economist at Merrill Lynch & Co., in New York. “Nevertheless, we expect the sharp rise in mortgage rates so far this year to reduce housing activity” after the fence sitters have made their moves.

The average 30-year mortgage rate rose 2 basis points to 8.03 percent during the week that ended Wednesday, according to the Federal Home Loan Mortgage Corp. The average rate is now a full percentage point higher than where it stood just 16 weeks ago, in early February.

Thursday’s housing report shows a key gauge of consumer demand, the supply of homes for sale nationwide, increased just 0.5 percent in April, even as the inventory of homes available at the current sales pace fell to the lowest level since last July - 5.8 months, from 6.1 months. That means builders expect demand for new homes to cool off as mortgage rates go higher.

As for the overall economy, “the forces pumping up second quarter growth are temporary,” Steinberg said. “We still expect the economy to slow during the second half of the year” as consumer spending and business investment taper off.

Thursday’s report is the second of three estimates of quarterly economic output. Another GDP revision will be published June 28, as more information becomes available to government analysts.