Fed Says Expansion Is Hampered by Increasing Costs


The Federal Reserve's survey of regional economies reported that the U.S. economy is expanding with job creation and ``ongoing cost pressures.''

The report also said that high food and energy prices are restraining consumer spending, which accounts for about two- thirds of gross domestic product. Sales of housing-related items such as furniture are ``weak or declining.''

``Economic activity continued to expand in June and early July,'' the central bank said in its survey, known as the Beige Book for the color of the cover. ``Contacts generally reported ongoing input cost pressures, particularly for petroleum-related inputs, while prices at the retail level continued to increase at a modest pace.''

The report backs Chairman Ben S. Bernanke's prediction of ``moderate'' growth this year followed by a pickup in 2008. The Fed is trying to steer the economy through a meltdown in subprime mortgage lending while inflation remains too high for the comfort of several policymakers -- risks the Beige Book addressed.

``Most districts said that residential construction and real estate activity continued to decline,'' the Beige Book said. ``Almost every region said that oil and gasoline prices were either rising, high, or `an issue.'''

A government report at the end of the week may show the economy expanded at an annual rate of 3.2 percent in the second quarter, according to the median forecast of economists surveyed by Bloomberg News. That compares with growth of 0.7 percent in the prior three months.

Hands Tied

``The Fed is not in a position to cut rates or hike rates,'' said Chief Economist Brian Wesbury of First Trust Advisors LP in Lisle, Illinois. ``Clearly, the economy accelerated in the second quarter, but I don't expect it to slow down that much as we move into the second half of this year.''

The Fed has left its main interest rate unchanged at 5.25 percent for a year. Futures markets show traders expect the Federal Open Market Committee to again vote to hold the rate steady at the conclusion of the Aug. 7 meeting.

Treasury notes were little changed after the report as concerns about credit-market risk held yields near the lowest in almost eight weeks. The yield on the benchmark 10-year note was 4.91 percent at 2:22 p.m. in New York.

The biggest risk to the six-year expansion is the housing slump, Bernanke told Congress last week. At the same time, inflation could worsen if energy and commodity prices start to feed through to other goods and services, he added.

Subprime's Ripples

The survey didn't dwell on the ripples that rising mortgage delinquencies are sending through Wall Street. Bear Stearns Cos. told investors in two failed hedge funds that they'll get little if any money back after ``unprecedented declines'' in the value of securities used to bet on subprime mortgages. At least 35 companies' borrowing plans were disrupted in the past five weeks.

Bernanke ``will have to begin to start cutting rates before the end of the year,'' said David M. Jones, president and chief executive of DMJ Advisors in Denver and a former economist at the New York Fed. ``I don't see him doing that. They're going to continue to worry about inflation while Rome burns on the credit side.''

Capital Spending

Manufacturing continued to expand during June and early July, and ``several reports indicated that capital spending increased,'' the Beige Book said.

Sales of existing homes in the U.S. fell more than forecast last month, a sign that residential real estate remains mired in its worst recession in 16 years. Purchases declined 3.8 percent to an annual rate of 5.75 million, the slowest pace since November 2002, the National Association of Realtors said today in Washington.

Inflation, excluding food and energy costs, has been at or above the upper end of the tolerance range of several Fed officials for three years. The Fed's preferred gauge, the Commerce Department's core personal consumption expenditures index, rose 1.9 percent for the 12-month period ending May...


Bloomberg
7/25/2007 2:05:44 PM