Fast moving economy may slump in 2005

WASHINGTON -- Despite soaring oil prices and a slumping dollar, the United States enjoyed a banner year in terms of economic growth in 2004, but the new year is likely to see a significant slowdown, private economists say.

Analysts believe that rising interest rates, the lack of new tax cuts and the lingering effects of higher energy bills will combine to slow growth next year.

"The performance of the U.S. economy in 2005 will be good but not great, at least in comparison to 2004," said Nariman Behravesh, chief economist at Global Insight, a private forecasting firm in Lexington, Mass.

But what a year 2004 turned out to be in terms of overall growth rates.

Many analysts believe that the gross domestic product -- the total output of goods and services -- grew by 4.5 percent for all of 2004. That would match the boom years of 1999 and 1997 and would be the fastest pace in two decades.

But even with sizzling GDP growth, consumer surveys indicate that many Americans did not feel particularly prosperous. Analysts attribute that to a job market that still has not recovered all the jobs lost since the start of the 2001 recession as businesses pushed hard to get more output from existing employees rather than hiring new workers.

Economists think this boom in productivity may be coming to an end as rising demand is forcing companies to hire more employees.

The latest survey of top economists done by the National Association for Business Economics is forecasting that 2.2 million jobs will be created in the new year, a slight improvement from 2004 with both years up significantly from the 61,000 jobs lost for all of 2003.

Analysts believe the current unemployment rate of 5.4 percent will fall gradually to just above 5 percent by the end of 2005. One reason they are not predicting a more dramatic decline is their belief that people who had given up looking for work will re-enter the labor market as they see hiring pick up.

Falling unemployment

A falling unemployment rate and growing jobs should translate into at least slightly stronger wage gains, many analysts believe.

"This could be the best year for the American worker since 2000 as the job market tightens up," said Mark Zandi, chief economist at Economy.com. "For the first time in five years, workers should be able to look forward to bigger wage increases."

The overall economy should grow next year by around 3.5 percentage points, according to Global Insight and other forecasting firms. While that is a full percentage point below the expected 2004 performance, analysts said it will still be a decent year, especially if their forecasts for solid employment growth turn out to be correct. The additional workers will boost income growth and support continued strong consumer spending.

The consumer, who accounts for two-thirds of total economic activity, has been the standout performer during the first three years of the current economic expansion, as President Bush's successive rounds of tax cuts and low interest rates from the Federal Reserve bolstered spending even as job growth lagged.

But for 2005, the impact of the tax cuts will be wearing off, and the Federal Reserve since mid-2004 has been gradually raising interest rates to make sure inflation does not get out of control.

Another factor cutting into growth is the cumulative impact of higher energy costs. Oil prices surged for much of 2004, hitting a record high of $55 per barrel in October. Oil prices have fallen by about $10 per barrel since then and many analysts think they will retreat to around $40 per barrel by next December.

If energy behaves, inflation is expected to moderate from an expected increase of 3.3 percent in 2004 down to 2.1 percent next year, according to a year-end survey of top economists by the Bond Market Association.

However, the forecast for moderating inflation is built on an assumption that there will not be a major terrorist-related oil supply disruption in the Middle East, a big unknown.

"If we had something unsettling happening in energy markets, it could easily create a scenario where oil prices could go up to $60 per barrel or even more and that would take a big bite out of consumers' pocketbooks," said Carl Tannenbaum, chief economist at LaSalle Bank in Chicago.

Another wild card is what will happen to the dollar, which has hit record lows against the euro, the common currency of 12 European countries, and has also fallen against the Japanese yen and other major currencies.

So far that decline has been gradual and welcomed by economists, who say it will help ease America's record trade deficits by making U.S. exports cheaper and more competitive on foreign markets.

But if the dollar suddenly started plunging in value against other currencies, that could spook foreign investors in U.S. stocks and bonds into stampeding for the exits, sending stock prices into free-fall and interest rates soaring.

However, if the dollar and oil prices behave as expected, economists said the country should enjoy another solid year of growth with stronger employment gains helping to bolster consumer confidence.

"Job security is the main issue for most people," said David Wyss, chief economist at Standard & Poor's in New York. "If we continue to see job growth of 175,000 or more per month and the unemployment rate keeps ticking down, then people should be happy."

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On the Net:

Global Insight: http://www.globalinsight.com

National Association for Business Economics: http://www.nabe.com

LaSalle Bank: http://www.lasallebank.com