Next year's economy: The forecast brightens

The economic gloom cast in the wake of hurricanes Katrina and Rita and the subsequent run-up in energy prices are subsiding. In its place are brighter prospects for 2006, considered a year of slowdown just three months ago.

That means America could enter a fifth year of economic expansion with solid growth, nearly on pace with this year.

Powering this brighter picture is the retreat of energy prices from record highs, prospects for stronger business investment, and a relatively vibrant job market. One indication the economy is back on track came Friday, when the Labor Department reported the economy created 215,000 jobs in November - a strong number in line with economists' expectations.

"Three months ago, we were hearing murmurings about a recession," says Anthony Chan, chief economist at JPMorgan Asset Management in Columbus, Ohio. "Now, the concern is the economy will be so strong next year, it will encourage the Federal Reserve to club it to death."

Through the fall, the consensus economic forecast was for economic growth of about 3.3 percent next year. At the end of this week, a new blue-chip economic indicator forecast is expected to come out with perhaps an increase to 3.5 percent. Last week, the Office of Management and Budget raised its forecast for 2005 by 0.1 percent to 3.5 percent and said next year the economy will grow at 3.4 percent.

That might even be on the low side, say some economists.

"Now that the hurricane effect is out of the way, the numbers are indicative of the actual strength of the economy," says Robert MacIntosh, chief economist at Eaton Vance, a mutual-fund group in Boston. "I'm optimistic next year it will be in the high 3s to low 4s, decent growth with low inflation."

The relatively strong economic news is expected to give the Federal Reserve room to raise interest rates another quarter of a percentage point next week. Some economists are expecting the rate increases to continue into next year.

"We're looking for three more rate increases by March," says Scott Anderson, senior economist at Wells Fargo & Co. "Certainly with the strong economic data we saw last week, topped off by the employment numbers, the market is expecting the Fed to keep increasing rates."

Yet another barometer of the future prospects of the economy, the stock market, has been on a tear this fall, with the Dow Jones Industrial Average closing in on 10941, the high reached in March. A broader measure of the market, the Standard & Poor's 500 Index, was up 3.5 percent in November.

"The main driver of the equity-market rally is the fading fears of inflation and more aggressive monetary policy tightening," says Alec Young, equity market strategist at Standard & Poor's. "Once investors saw that energy price increases were not feeding through into the core inflation data as much as people thought they might, there was a feeling that after December we might see the end of Fed tightening."

Oil prices are down about $11 a barrel from the days immediately after Katrina. After edging above $3 a gallon, gasoline prices are now down to about $2.08, according to GasPriceWatch.com.

"If you go back just 90 days, there were credible assertions of $100-a-barrel oil," says Richard DeKaser, chief economist at National City Corp. in Cleveland. "No one is talking about that anymore."

The economy, however, is not without risk. As mortgage rates have gone up, the housing sector has started to slow. This was reflected last week in a decline in sales of existing homes. Sales of new homes, buoyed by price cuts, saw a burst of activity. "But the bulk of the indicators, anecdotally and from other sources, indicates some softening and plateauing," says Mr. Anderson of Wells Fargo.

The auto sector may also be a drag on the economy. Last week, Ford Motor Co. said it would close five assembly plants that provide jobs for 7,500 workers. Recently, General Motors said it would shed 30,000 jobs next year.

"Some will be absorbed in other sectors. Some will get hurt," says Anderson.

Despite those layoffs, some experts are optimistic about the prospects for the labor market. The November labor gains are just the forerunner of a "hiring frenzy," says John Challenger, chief executive officer of Challenger, Gray & Christmas, an outplacement firm in Chicago.

"There is a lot of extra fiscal stimulus moving into the economy from the storm relief," says Mr. Challenger. Indeed, the latest economic numbers indicate 24 percent of the new jobs were in the construction business.

Challenger also expects strong hiring in technology, energy, international business, and biotechnology.