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US economy forges ahead

Growth surprise: GDP rise confounds market expectations but inflation stays under control

Economics Editor

The US economy sprinted ahead in the third quarter, but inflation remained firmly under control, with a key indicator showing its smallest increase in over 30 years. Both the growth and the inflation figures confounded market expectations.

After increasing at an annual rate of only 1.3 per cent in the second quarter, real GDP jumped by 4.2 per cent, its highest since the exceptional growth at the end of last year. The increase was much more than the 2.6 per cent markets had been expecting.

The result was an immediate sell-off in Treasury bonds as dealers hastily revised their hopes of a cut in interest rates by the US Federal Reserve when it meets on 15 November. The 30-year bond fell by about a point on the news. However, it then retraced the entire fall and by early afternoon was trading half a point above Thursday's close.

Stocks also fell back by 28 points on similar fears that interest rates would be held at their present level of 5.75 per cent. By early afternoon, however, the Dow Jones Industrial Average was up by around 25 points.

Inflation stayed firmly under control despite the spurt in growth. The implicit price deflator rose only 0.6 per cent, the smallest increase for 32 years and much less than the 1.6 per cent rise in the second quarter and the 1.9 per cent increase expected by the markets.

President Bill Clinton said the growth figure showed that the economy was "on the right track". However, he warned the Federal Reserve against moving interest rates up: "I don't believe the growth figure should raise interest rates because inflation is so low."

Mark Cliffe, international economist at HSBC Markets, said: "The realistic chances of a rate cut have been put back to the 19 December meeting by which time it's possible there may be a budget deal.

The US Fed has indicated that it may be prepared to loosen monetary policy to match a tightening in fiscal policy.

The growth occurred because consumers splashed out on durable goods, exports bounded ahead and housing recovered. Government spending also rose sharply.

Consumption of durable goods rose by 12 per cent. Housing investment rose at an annual rate of 11 per cent after falling by 14 per cent in the second quarter and 4 per cent in the first. Exports increased at an annual rate of 11 per cent.

Another reason the expansion was higher than had been expected was that inventories did not pull growth down as they had done in the second quarter when they depressed it by 1.2 per cent.

Economists had been expecting further destocking to depress growth by nearly 1 per cent. Instead, restocking contributed modestly to growth.

The rebound in the bond and stock markets came as economists and dealers peered more deeply into the details of the performance of the economy in the third quarter.

The general conclusion was that third-quarter strength may be followed by weakness in the fourth quarter - particularly as, on the initial evidence of department store and car sales, the fourth quarter "has started on a weak note", according to Mr Cliffe.

Although business investment was stronger than had been expected, much of the growth was concentrated in personal computers, something which may not continue.

And it continued to slacken from the strong growth rates chalked up in the past three quarters.

At 8 per cent, it was down from 11 per cent in the second quarter, 22 per cent in the first quarter and 14 per cent in the final quarter of 1994.

Government spending is also expected to be flat in the final quarter. Another query over the underlying strength of the economy is whether export growth will continue to be as strong as projected by official statisticians.

There is also potential for revision in the trade figures. Official statisticians apparently projected the strong performance in August into their estimates for September.

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