WASHINGTON -- In its most upbeat economic report in at least a year, the Federal Reserve said yesterday that gains in manufacturing, housing, and retail sales are bringing improved business conditions in most regions of the United States.

"Economic activity continues to improve," says the Fed's so-called beige book, a compilation of surveys collected before June 9 from the 12 Federal Reserve district banks.

And, according to the report, there are signs that the credit crunch is finally easing. Loan demand "appears to have increased slightly in most districts," with some districts reporting increased applications for consumer loans, and others citing requests for business loans.

Kansas City and San Francisco said demand for both types of loans have increased.

The positive tone of the report reinforces the notion that Fed policy makers will stick to their neutral policy on interest rates while they watch what is by all measures a mild recovery continue to unfold. The Federal Open Market Committe, the Fed's policy arm, is scheduled to review monetary policy at a meeting June 30 and July 1.

"We think they're trying to achieve slow growth of the economy because they want to attack the long end of the yield curve by getting rates down," said Mitchell Held, chief financial economist for Smith Barney, Harris Upham & Co. "Just because the economy is recovering doesn't mean inflation must accompany it."

Federal Reserve Board Chairman Alan Greenspan, in comments this week to a House Government Operations subcommittee, said he expects further reductions in inflation and expressed frustration that bond market participants are continuing to fret that Fed policy makers will permit a rebound in prices.

Federal Reserve Board Governor Edward Kelley said in an interview yesterday that Fed officials are confident the U.S. economy will continue to expand throughout the year. "From all one can tell, it is our very best judgment that we have a sustainable recovery going here," Mr. Kelley said.

'I do not think it is going to generate the kind of growth numbers that we have seen in some recoveries, but I do believe that it is going to be sustained, and I do belive it is going to accelerate from where it is," Mr. Kelley said.

He added that while he does not anticipate a rebound in inflation over the next several quarters as the economy gains momentum, Fed officials will have to remain vigilant "to insure that we don't put conditions in place that enable inflation to resurrect itself in the" future.

According to the beige book, "all districts report improving manufacturing conditions, except for the defense and aerospace industries." The districts of Cleveland, Dallas, Philadelphia, St. Louis, and San Francisco reported modest increases in orders, while Atlanta and Chicago reported "much sharper gains."

The only sour note in manufacturing shows up in exports, where demand "seems to be waning because of weakening foreign economies," the report says. That could be worrisome because exports have been a major force helping sustain the economy in the last several years.

Most districts reported increases in merchandise sales, and auto sales are up in most regions, the report says. Consumer spending accounts for two-thirds of total U.S. output of goods and services, and is critical to sustaining growth.

Home building "continues to be a source of strength in most districts," the Fed report says. "While construction has stabilized or dropped off slightly in some districts since its first-quarter surge, contacts in the Atlanta, Kansas City, Minneapolis, Richmond, and St. Louis districts describe the pace of residential building activity as strong." Home prices are up in several districts, the report adds.

On a regional basis, the Fed's beige book said pockets of economic weakness remained in California and parts of the New York, St. Louis, and Boston districts.

Separately, the Conference Board said in its latest quarterly survey that business confidence has jumped to the highest level since 1984. The New York-based research organization's index of business confidence advanced to 70 from 62 in the first quarter. The index, which hit a low of 55 in the fourth quarter of last year, takes readings that go as high as 100.

Nearly 80% of the firms surveyed said economic conditions have improved during the past six months, up sharply from 30% in the prior survey. Asked about conditions in their own industries, 65% were optimistic compared to less than 40% in the last survey.

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