January 02, 2006
Monday AM

As the nation enters its fifth year of an economic expansion, the big question is: Will the economy be naughty or nice in 2006?

The consensus seems to be nice, although probably not as agreeable as it was this year.

The economy surprised many forecasters in 2005, quickly regaining its footing after a battering by hurricanes and energy prices.

"You can't help but be impressed with the U.S. economy's performance in 2005," said Bernard Baumohl, executive director at The Economic Outlook Group in New Jersey.

"Its resilience in just the last few months has been nothing short of remarkable. There was lots of talk of stagflation, recession, a plunge in confidence, a collapse in housing, and consumer spending shutting down. But none of these scenarios materialized."

Instead, the gross domestic product actually picked up in the third quarter and is expected to finish with a gain of around 3.7 percent for all of 2005, down modestly from the robust 4.2 percent growth posted in 2004. Inflation remained relatively tame, unemployment held steady and job growth was satisfying as crude oil and gasoline prices dropped back from record highs and rebuilding began along the Gulf.

Heading into 2006, most economists are forecasting solid growth ranging from about 2.8 percent to 3.5 percent, below the last two years but better than at the beginning of the expansion cycle in 2002 and 2003, when GDP - a broad measure of the value of the nation's goods and services - rose by 1.6 percent and 2.7 percent respectively.

Business spending should be the hot spot next year as businesses, flush with cash, look to further improve productivity and reduce operating costs by upgrading plants and equipment.

Consumers, meanwhile, who have been spending like crazy the last four years, will pull back, buying fewer new homes, cars and other big-ticket items and will focus on saving again, economists say.

"With the housing sector now cooling and interest rates rising, the home equity cash faucet (which has been feeding consumer spending) is about to dry up," Baumohl said.

Still, a more frugal consumer won't be a show stopper, Global Insight economist Brian Bethune said.

His firm is forecasting consumer spending will grow 3.1 percent next year compared with an estimated 3.5 percent in 2005, while the Economic Outlook Group projects less sprightly growth of 2.5 percent in 2006 on the heels of an estimated 3.3 percent this year.

"Business investment is going to be one of the principal drivers of growth in 2006," Bethune said. "The consumer will still be there ... (but) certainly won't be as ebullient as the last four years."

Most economists expect inflation to remain tame in 2006, averaging slightly below the estimated 3.5 percent range this year as energy prices stabilize.

The Federal Reserve is widely believed to be nearing the end of an inflation-fighting campaign that resulted in short-term interest rates going up 13 times in the last 18 months.

Bethune says the Fed will boost the target federal funds rate on overnight bank loans two more times early next year, raising it to 4.75 percent from 4.25 percent, before taking a long breather. Many economists believe fed funds at 4.75 or 5 percent would be considered a neutral rate - a level that neither encourages nor restrains economic growth.

The outlook for the jobs market also is good, with the unemployment rate expected to hold fairly steady at around 5 percent and the country projected to create another 2 million net jobs.

Overall, economists see little likelihood of a recession for the next couple years.

According to Global Insight, a recession would require the convergence of two or more "big shocks" to the economy, such as oil prices above $100 a barrel, inflation and interest rates running three percentage points above current levels and a 10 percent drop in home prices.

"All are possible but unlikely in either 2006 or 2007," the forecasting firm said.

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