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Reports on Jobs and Housing Fan Inflation Fears : Economy: Surprising figures bolster worries that the Fed will raise rates soon. Stocks and bonds pay the price.


Another round of bullish economic news, including a surprising 4.4% nationwide surge in September housing starts and an unexpected drop in new jobless claims, reignited inflation fears Thursday, sending stock and bond prices skidding.

A Commerce Department report showing new homes in September being built at their fastest pace of the year--fueled by a 21% surge in the West--prompted many analysts to speculate that the Federal Reserve Board will once again raise interest rates to cool the economy and keep inflation from soaring.

Despite five Fed-engineered boosts in interest rates since February, housing starts shot up to a seasonally adjusted annual rate of 1.53 million units, the highest since last December, when it reached 1.61 million, the peak of the current economic expansion. And both the July and August gains were stronger than initially estimated.

In addition, the government reported that a post-earthquake surge of 3.9% in the personal incomes of Californians--boosted by billions of dollars in federal aid and insurance payments in the aftermath of the January Northridge temblor--fueled a 1.9% overall gain in the income of the average American in the second quarter.

The strong economic news was blamed for the Dow Jones industrial average tumbling 24.89 points to close at 3911.15, wiping out a 25-point gain over the previous three days. The yield on the benchmark 30-year Treasury bond, which rises when bond prices fall, climbed to 8% for the first time in more than two years before falling back slightly.

The latest government reports on prices have suggested that rising inflation remains more a threat than a reality. But the economy has shown few signs of slowing down, and many economists say that at least one more boost in interest rates is now a foregone conclusion.

"I think the Fed will raise rates by a half-point or so after next month's election, and then push it up again around the end of the year," said Robert Davis, chief economist of the Savings and Community Bankers of America in Washington.

Separately, the Labor Department reported that the number of Americans seeking unemployment benefits for the first time posted an unexpected decline of 3,000 last week to a seasonally adjusted 326,000. Analysts had expected an increase of 4,000.

In addition, the Philadelphia Fed said manufacturing activity surged during October in eastern Pennsylvania, Delaware and southern New Jersey. The number of manufacturers reporting higher prices for raw materials in the region also increased.

Bond investors are already demanding higher yields to protect themselves against a comeback in inflation, which would erode the value of their holdings. Thursday's 8% yield on the 30-year bond was up from 7.89% on Wednesday, and the highest since May, 1992.

"The economic data is now clearly indicating that the economy is not slowing down and that inflationary pressures are, if anything, intensifying," said Joseph McAlinden, chief market strategist at Dillon, Read & Co.

September's 4.4% gain in new-home construction nationwide was fueled by a sharp 21.4% increase in the West. Big increases in Arizona and Nevada offset continued weakness in California's construction industry, analysts said.

* DOLLAR FALLS: The U.S. dollar flirts with a post-World War II low in Tokyo. D2

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