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Markets Rise on Economy's 3.4% Quarterly Surge


WASHINGTON — The U.S. economy expanded at a healthy annual rate of 3.4% during the third quarter of the year, the Commerce Department said Friday, reporting a bigger-than-expected growth spurt that increases the likelihood of additional interest rate increases by the Federal Reserve Board.

While most analysts and economists are convinced that the Fed is likely to boost rates at its next policy-making meeting on Nov. 15, the financial markets greeted Friday's report with enthusiasm.

The Dow Jones industrial average surged 55.51 to 3930.66, enjoying its biggest daily rise since a 61.2-point jump on Oct. 11. The yield on the Treasury's key 30-year bond fell to 7.95%, another sign of confidence.

Investors and traders were reassured because the report on economic growth also contained a modest inflation figure, an annual rate of just 2.7% during the quarter, measuring prices paid by businesses as well as consumers.

The combination of moderate growth and mild inflation suggests that the expansion can be sustained with only modest adjustments in interest rates to keep prices in check, analysts said. However, there are some price increases for commodities and tightening of labor markets for several categories of skilled workers.

"The economy is not overheating," said Robert Barr, deputy chief economist for the U.S. Chamber of Commerce. "We think the Federal Reserve wants to err on the side of having less growth and less inflation--that's why they are probably going to raise rates at the next meeting," he said.

The issue now seems to be not whether the Federal Reserve will increase interest rates, but by how much. Since five rate hikes have not slowed the economy appreciably since February, the Fed is likely to believe that it can keep squeezing without running a serious risk of tipping the country into a new recession.

Friday's reported 3.4% growth rate in the economy is substantially higher than the 2% to 3% figure predicted by many economists.

The expansion in the national economy is measured through the gross domestic product--a statistical attempt to count every economic transaction in the country from haircuts to movie ticket sales to the fabrication of a ton of steel. The GDP increase of 3.4%, or $45.1 billion, during the year's third quarter, compared with an advance of 4.1% in the previous period, according to the Commerce Department's Friday report.

The economy's expansion was driven largely by enthusiastic consumer spending, noted Laura D'Andrea Tyson, who chairs the President's Council of Economic Advisers. Consumer outlays rose a hefty $26.1 billion during the quarter ended Sept. 30, compared to $11.5 billion in the previous quarter. There was a strong "rebound in purchases of motor vehicles from a sharp drop in the second quarter," said Lewis Alexander, the department's chief economist.

The brisk demand for products during the summer also generated a boost in business inventories, as companies expanded output to meet a surge in orders. For example, production of some popular car models and home computers has been unable to keep pace with demand.

Business investments in new equipment and machinery also continued growing at a rapid rate during the quarter.

Clinton Administration officials hope that Friday's news will translate into political gains for many beleaguered Democratic candidates. The GDP report, combining strong growth with low inflation, "is the best of all possible worlds where economic facts and figures are concerned," Vice President Al Gore told reporters at the White House.

But Republicans appear to be convinced that they can make big gains at the polls Nov. 8 and that the market's uncertain pattern in recent months represents a rejection of President Clinton's policies.

"What we're trying to point out is that we're at a crossroads," said Rep. H. James Saxton (R-N.J.). "We think we are headed in the wrong direction."

The economy's production of goods and services has increased at a rate of 4% during the past four quarters, far above the 2.5% figure considered by Fed officials to produce growth without inflation.

"If you listen to what (Federal Reserve Chairman) Alan Greenspan says, you have to believe the Fed looks at this GDP report and it strengthens the case for higher interest rates," said Marko A. Budgyk, managing director of Houlihan Lokey Howard & Zukin, a Los Angeles investment management firm that handles funds for institutions and wealthy investors.

Michael Penzer, vice president and senior economist for Bank of America, agreed with that assessment, noting that inflation over the last four quarters has been "fairly low and modest."

To reach the Fed's desired growth rate of 2.5%, Penzer said, the central bank needs to drive up the federal funds rate, the interest rate banks charge each other for overnight loans. The figure, now 4.75%, is likely to go to 5.25% after the next meeting of the Fed's Open Market Committee, he predicted.

He said that he hopes the strategy will work. "I'm optimistic they will get the soft landing they want, reaching 2.5%" without producing a recession, he said.

* BULLISH REACTION: Stocks surged and bond yields dipped on the GDP report. D1

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