Economy Gained Strength In 2006

A team of workers spreads concrete for the basement floor of a new home in Erie, Colorado Monday, September 18, 2006. Builders probably started work last month on the fewest new houses in three years as higher mortgage rates discouraged home buyers, economists said ahead of a U.S. government report today. (Kevin Moloney/Bloomberg News.)

Nonetheless, overall economic growth rebounded in the last three months of the year, with gross domestic product, the value of all goods and services produced in the country, rising at a robust 3.5 percent annual rate.

Unemployment drifted lower through the year, to 4.5 percent in December from 4.9 percent a year earlier. The job market remained tight as employers in health, education, finance and other service industries created many more new jobs than were cut by mortgage lenders, home builders and automakers.

And the economy got a lift as oil prices tumbled to about $61 a barrel by the end of 2006 -- about where they had been a year earlier.

Drivers paying less at the pump had more to spend on shopping during the holiday season. Consumer spending rose at a blistering 4.4 percent annual rate in the last three months of the year, the Commerce Department said yesterday.

Falling oil prices helped shave the nation's import bill at year-end, and strong economic growth overseas boosted demand for U.S. exports. The Commerce Department estimated that the improvement in trade added 1.6 percentage points to the rate of economic growth in the fourth quarter.

Businesses continued to build more offices, factories and other types of nonresidential structures, helping to cushion some of the effect of the housing downturn on construction industries.

And unusually warm weather probably prompted more shopping, hiring and construction than would have occurred in colder conditions, several economists said.

Although some of the year-end momentum reflected such temporary factors, analysts said, the tight labor market bodes well for 2007.

The Commerce Department report "shows you the ability of the economy to ride out the storm of the housing market," said Wells Fargo's Alem?n. "The rest of the economy is so strong." Inflation also cooled slightly last year. Consumer prices rose 2.8 percent, a bit less than the 2.9 percent gain recorded the year before, the agency said.

Many economists seek a sense of underlying inflation by looking at so-called core inflation, which excludes volatile food and fuel prices. Core prices rose 2.1 percent in 2006 after rising 2.2 percent in 2005.

The Fed noted the improvement but said in a statement that "inflation risks remain" because of the possibility that the tight labor market will fan price pressures.

A separate Labor Department report yesterday showed that wages and salaries rose 3.2 percent last year, the fastest rate in five years.

Employers' labor costs -- including both pay and benefits -- rose 3.3 percent in 2006, up from the 3.1 percent gain in 2005.

Several analysts said the gains should not alarm the Fed. "Employers' labor costs remain moderate and do not appear to be generating inflationary pressures," said Jared Bernstein, senior economist at the Economic Policy Institute.

The economy is likely to grow about 2.4 percent this year -- more slowly than last year but at a moderately good pace -- according to the average prediction of economists surveyed by Blue Chip Indicators, a monthly publication.

Housing is likely to remain a drag on growth. Builders are still stuck with bloated inventories of unsold homes. Unemployment may rise this spring when builders break ground on far fewer new homes.

But several analysts said that despite these lingering soft spots, the Fed appears to have achieved the Holy Grail of central banking -- a "soft landing" in which it raised interest rates last year just enough to cool price pressures without triggering a recession.

Now, the central bank is likely to leave interest rates on hold for a while, said Nariman Behravesh, chief economist for Global Insight. "The Fed has the economy where it wants it."