'Beige book' says rate hikes' effects are beginning to show.

WASHINGTON -- The economic expansion marched forward in May and early June but with hints that higher interest rates are beginning to slow growth, according to the Federal Reserve's latest survey of business conditions released yesterday.

"Districts report continued economic expansion, although in some areas growth has moderated recently," said the Fed's "beige book." Higher interest rates were said to have restrained the housing market and bank lending in selected areas, the report said.

"Home sales in most areas continued at a strong pace, and residential construction remains generally brisk, but some slowdowns in response to rising mortgage rates were noted," Fed officials said in the report. "Loan demand is generally increasing, although rising interest rates have precipitated declines in some areas."

In many areas, higher mortgage rates were cited "as a source of emerging or potential weakness," the report said. The report also said that, single-family homes continued to provide most of the strength in residential construction.

The beige book summarizes information about current economic conditions compiled from business surveys conducted by the Fed's 12 regional banks. The report is used by the Federal Open Market Committee, due to meet next on July 5 and 6, as a basis for discussion in setting monetary policy. Most analysts expect the officials to hold rates steady at the meeting, but there is speculation that another tightening of short-term rates could come in August.

Retail sales provided another possible sign of a softening economy. "Contacts in a number of districts report slower-than-expected growth in May retail sales," the report said, but added that there were "some signs of increasing sales in early June."

Retailers in several areas attributed the slowdown to unseasonably cool weather in May, the report said. And several districts reported that auto sales were restrained by shortages of certain popular car models.

In addition, "foreign demand for products from most districts remains somewhat sluggish," the report said.

Meanwhile, the industrial sector continued to expand. "Manufacturing continued to show strength in most districts, with many contacts reporting increases in new orders and shipments," the report said. Defense-related industries continued to be the exception.

On the inflation front, the Fed report said industrial materials prices were on the rise in more than half the districts surveyed, but that competitive pressures "are mitigating price increases for finished goods." However, the report went on to say that "in many instances" the reported price pressures were "modest."

Businesses in some areas reported tightening labor markets, but with only moderate wage pressures, according to the report. "Tightening labor markets were noted in the Atlanta, Chicago, Minneapolis and Richmond districts," and respondents in the Philadelphia district reported continued increases in employment benefit costs, the report said.

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