The Fed: Economy Grew at a 'Modest Pace' in September

The latest Beige Book report by the U.S. Federal Reserve confirms what earlier economic data has indicated: U.S. economic activity "continued to rise, but at a modest pace," during the reporting period from September to early October.

Collecting reports from the Fed's 12 regional banks, the latest Beige Book added that manufacturing sector growth -- which has led the recovery so far -- continued to expand, while retail spending was flat to moderately higher. The Fed said hiring demand "remained limited," and wage pressure was slight. Some increases in loan demand were noted, but home sales remained weak. Inflation stayed subdued.

Eight of the 12 regional Fed banks, including San Francisco and Chicago, reported some form of growth in the September/October period, the Fed said.

Minimal Wage Pressure

Concerning the nation's industrial sector, the Fed said "manufacturing activity continued to expand, and several Districts reported gains in production or new orders across a wide range of industries." The only exceptions were the Philadelphia and Richmond districts, where activity softened compared with the previous reporting period. Exports boosted activity in the Cleveland, Chicago, and Kansas City districts.

Regarding retail spending, the Fed said it was "flat to moderately positive in most Districts, with the exception of the Richmond and Atlanta Districts, which noted declining traffic and sales." The Kansas City district noted that sales were stronger than expected, and back-to-school spending boosted sales in the Philadelphia and Dallas districts. Retail spending grew modestly in the Minneapolis and San Francisco districts, and was flat in the Cleveland, Chicago and St. Louis districts.

On the inflation front, wage pressure was minimal, the Fed said, with most districts finding little evidence of wage increases in general. However, "there were widespread reports across Districts that firms anticipated increased costs of employee benefits as a result of health care reform."

Lending: Stable at Low Levels

About jobs, the Fed said "hiring remained limited, with many firms reluctant to add to permanent payrolls given economic softness. Reports from staffing firms were mixed. Staffing firms in the New York and Dallas Districts noted a slowdown in demand for their services, and contacts in the Cleveland District said new job openings declined." The Richmond district noted a pickup in demand for temporary workers. Philadelphia said businesses were adding positions as workloads increase. And Atlanta noted a preference for increasing hours of existing staff and hiring temporary help, rather than bringing on full-time employees.

Regarding banking conditions, the Fed said "lending activity was stable at low levels across most Districts, but there were some reports that demand picked up slightly." Demand for commercial and industrial loans remained weak, as businesses continued to postpone capital spending plans, due to economic and public policy uncertainties. However, the Fed added that "merger and acquisition lending activity picked up in a few Districts."

The housing sector remained weak, with most districts indicating that "overall home sales were sluggish or declining, and were below year-ago levels." A few districts showed housing sector improvements: the Philadelphia, Richmond, Kansas City and Dallas districts reported upticks in sales of higher-priced homes. Home prices were generally stable from the Fed's last report, in September.

Sounding a Deflation Warning

The latest Beige Book and analysis revealed almost no data that are likely to sway the Fed from a probable extension of its quantitative easing policy, the so-called QE2, to help stimulate the U.S. economy. And Fed Chairman Ben Bernanke has already indicated that both job growth and inflation are too low for the Fed's liking -- the latter getting dangerously close to deflation -- that unwanted, commercial-activity-sapping condition.

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Bernanke, in a Boston speech last week, telegraphed to investors, business executives and policymakers that inflation has dropped about as low as the Fed wants it go. "Further disinflation would be unwelcome," he said, adding that an inflation rate greater than zero would be the Fed's goal.

"Committee participants have generally judged that a modestly positive inflation rate over the longer run is most consistent with the [Fed's] dual mandate [of price stability and full employment]," Bernanke said in the Boston speech. "The view that policy should aim for an inflation rate modestly above zero is shared by virtually all central banks around the world."

Top-line inflation over the past 12 months is running at a low 1.1% rate, and the core rate is a minuscule 0.8% -- the lowest year-over-year core rate since 1961 and down from the 0.9% registered in August. Further declines would probably signal that deflation has started.