Economic Growth Setting Record Pace for the Year

The U.S. economy is now growing at its fastest pace in 18 months as analysts increase their forecasts for the fourth quarter.

Economists at JPMorgan (NYSE:JPM) in New York now see gross domestic product rising 3% in the final quarter, up from a previous estimate of 2.5%. Macroeconomic Advisers in St. Louis has upwardly revised its forecast from 2.9% to 3.2%. Morgan Stanley (NYSE:MS) has boosted its outlook from 3% to 3.5%.

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“The incoming data on consumption, business spending and residential investment all point to GDP growth in the fourth quarter tracking 3.3 percent,” said John Herrmann, senior fixed-income strategist at State Street Global Markets in Boston.

Recent economic reports show that consumers have no been cutting back on spending despite the financial turmoil that has been riling global markets. Retail sales rose 0.5% in October, helped by the biggest jump in electronics sales in two years.

Karen Hoguet, chief financial officer for Macy’s (NYSE:M), is predicting that trend will continue.  “We feel confident that the momentum we have heading into the fourth quarter, combined with our holiday strategies, bode well for that quarter.”

After keeping a tight rein on inventories over the past few months, companies have now begun to restock, which JPMorgan predicts will boost growth by 0.8% in the fourth quarter. Inventory changes reduced GDP by 1.1% in the third quarter.

The economic pick up should help revive markets, and may also push up yields on Treasury securities, assuming Europe is able to avoid a financial catastrophe akin to that of 2008, said Herrmann.

However, analysts are only giving their forecasts for the current quarter. What happens after will depend heavily on what policymakers do in both Europe and the U.S., said Michael Feroli, JPMorgan’s chief U.S. economist.

The U.S. would not be able to “escape the consequences of a blowup in Europe,” Federal Reserve Chairman Ben S. Bernanke said in El Paso, Texas on November 10. “The world’s financial markets are highly interconnected.”

Federal Reserve Bank of New York President William C. Dudley said in a speech yesterday that while recent economic reports have shown improvement, that shouldn’t be a signal for the Fed to relax its efforts to boost the economy. Growth next year may be around 2.75 percent after somewhat more than 2.5 percent in the fourth quarter, he said.

“Although the latest news on the U.S. economy is somewhat more encouraging than that from earlier in the year, we should not take much solace from that,” Federal Reserve Bank of New York President William C. Dudley said in a speech yesterday. “The U.S. economy continues to face several obstacles,” including consumers cutting debt and caution by businesses.

“We also continue to face significant downside risks, mostly related to the stress in the euro zone,” said Dudley. He expects growth next year to be around 2.75% after fourth-quarter growth north of 2.5%.

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However, if Congress doesn’t follow through on a number of stimulus measures due to expire at the end of the year, including a 2% cut in employee payroll taxes and extended unemployment benefits, “the drag from tightening fiscal policy could subtract 1.5 to 2 percentage points from GDP growth next year,” said JPMorgan’s Feroli.