Slower Growth, Higher Inflation Loom

Slow growth and higher borrowing costs may be in store for the U.S. economy in 1997 as consumer prices creep higher and job markets remain tight, analysts are predicting.

U.S. growth is likely to slow to 2.1 percent this year from this year’s increase of about 3 percent in the gross domestic product, according to analysts surveyed by Bloomberg Business News. More ominously, they predicted it may be accompanied by a pickup in inflation.

As a result, most of those surveyed expect Federal Reserve policy-makers to raise the federal funds rate on overnight bank loans above its present 5.25 percent rate in 1997 as job creation continues to be relatively strong and the unemployment rate stays below 5.5 percent.

“The next move will probably be a tightening, sometime in the second quarter,” said John Ryding, senior economist at Bear Stearns & Co. in New York. “Labor pressures will keep them biased toward tightening, even though there are no signs of inflation outside of wage pressures.”

Fed Gov. Laurence Meyer, who’s known for his forecasting prowess, offers a word of caution about this consensus outlook, however. He said in an interview that if the economy expands by no more than 2.25 percent as he expects in 1997 and there are no economic shocks from abroad, the Fed won’t have a reason to raise - or lower - the federal funds rate on overnight bank loans for many months to come.

“The economy seems pretty well balanced and pretty healthy,” Meyer said. “There are not a lot of excesses out there right now. The important word here is the risks are balanced.”

Still, Meyer said he remains concerned that the economy could grow faster than he expects.

One thing that could cause that to happen is if employment growth picks up. Through the first 11 months of 1996, monthly job creation averaged 205,000, up from 185,000 in all of 1995. Also in the first 11 months of this year, the consumer price index was running at a 3.3 percent annual rate, up from a 2.6 percent pace in the same period a year earlier and a 2.5 percent rise for all of 1995.

Some analysts, such as Kathleen Stephansen, senior economist at Donaldson, Lufkin & Jenrette Securities Corp. in New York, expect U.S. growth to slow in 1997. Stephansen forecasts a growth rate for the year of just 0.75 percent. It that happens, she says, interest rates will fall.

“We’re looking for a hefty cut to 4 percent on the federal funds rate by mid to late next year,” Stephansen said in December. She expects the economy to grow at a 1 percent rate in the first half of the year and then slow to a 0.5 percent pace in the last six months of 1997.

Whichever camp is right, recent evidence shows that growth has come in fits and starts. Americans “took a holiday in the third quarter,” for example, when growth slowed to a 2.1 percent annual rate, said Tim O’Neill, chief economist at Harris Bank/Bank of Montreal. That was down from the second quarter’s 4.7 percent pace.

Growth likely accelerated in the fourth quarter as holiday buyers flocked back to the malls, O’Neill said. That’s important to economic growth because two-thirds of GDP comes from consumer spending on everything from washing machines to housing and medical care.

Additional strength in 1997 is likely to come from factory output. In November, industrial production surged by the largest amount in nine months as strikes against General Motors Corp. ended, according to the Fed. Production at factories, mines and utilities increased a largerthan-expected 0.9 percent in November after falling a revised 0.2 percent in October.

“Even after you make allowance for the increase in auto output that resulted from the termination of the GM strike, that was a very strong industrial production number,” said former Fed Gov. Lyle Gramley. “We’re getting a good degree of increase in industrial output in the fourth quarter, and that means the economy still has a lot of momentum.”

The Fed has left its federal funds target for overnight loans between banks - its main monetary policy tool - unchanged at 5.25 percent since Jan. 31, when it cut the rate by 25 basis points.

As a practical matter, the Fed’s public announcement of changes in the so-called federal funds target quickly reverberates through money markets. The fed funds rate fluctuates daily, tends to move to near the Fed’s target almost immediately, and banks adjust their prime lending rates a short time later.

MEMO: This sidebar appeared with the story: ECONOMIC FORECASTS Following is a table of economists polled and their forecasts for 1997 GDP growth and central bank interest rate policy: Bear Stearns, John Ryding, 2.4%, poised to rise. BT Securities, John Williams, 2.5%, poised to rise. Chase, Charles Lieberman, 2.7%, poised to rise. Dean Witter, Steve Ricchiuto, 2.5%, poised to rise. DLJ, Kathleen Stephansen, 0.75%, poised to cut. Harris Bank, Tim O’Neill, 2.4%, hold steady. MBA, Lyle Gramley, 2.0%-2.25%, poised to rise. Moody’s, John Lonski, 2.2%, hold steady. PaineWebber, Maury Harris 2.2%, hold steady. Scudder, Maureen Allyn, under 1.0%, poised to cut.