The nation's economy, so remarkably strong for so long, could finally be on a collision course with higher interest rates.
In its initial estimate of first-quarter economic activity, the Commerce Department said Friday that gross domestic product grew at a 4.5% annual rate, much faster than the 3.3% most economists had expected.
Moreover, the implicit price deflator, a broader measure of inflation than the consumer price index, showed prices rising at a 1.4% rate in the first quarter, up sharply from 0.8% in the fourth quarter.
The report quickly led to a jump in bond yields and a slide in bank stock prices as some economists said the Federal Reserve's monetary policymakers may eventually be pushed toward a rate hike.
"If the employment cost index hadn't looked so good just a day earlier, we might now be anticipating some action at the Fed's May meeting," said Nicholas S. Perna, chief economist at Fleet Financial Group in Boston.
"The Fed will do everything it possibly can to avoid tightening" credit, he said. "But at some point in the second half of the year they could get scared of the economy overheating if we don't see a slowdown."
Others think a rate hike, if it happens, is more likely to come early next year, provided there are no severe business disruptions from century- changeover problems in computerized data systems.
"If Y2K does not sink the ship, a global recovery could add enough to potential inflation to finally push the Fed to raise interest rates," said David Orr, chief capital markets economist at First Union Corp. of Charlotte, N.C.
Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y., also said he thinks chances of a Fed rate hike are higher early next year.
"By then, we think the domestic case for higher rates will have become much stronger, with wage inflation picking up and the unemployment rate heading to 3.5%," he said. "We also think there is a real risk that core inflation will have begun to rise, principally because the booming housing market is pushing up prices and rents."
In addition, economic recovery may then be under way in Asia and elsewhere, "easing the sense of global crisis and thereby opening the door for the Fed."
Of course, Mr. Shepherdson said, this scenario "assumes the Y2K problem will not have wrecked the global economy."
As Mr. Orr sees it, the risks in the current economic outlook are based on the extreme imbalances between areas like consumer spending, which roared ahead at a 6.7% annual clip in the first quarter, and the nation's huge and growing international trade deficit.
However things are reconciled, the Goldilocks mix of business conditions prevalent for much of this decade-"not too hot, not too cold"-may finally fade.
"The Fed is hopeful the imbalance is resolved over the course of 1999 by moderation in consumer spending and housing, checking the surge in imports," Mr. Orr said. "At the same time, they are hopeful that foreign economies will begin to rebound and absorb more U.S. exports, thus chipping away at the trade deficit."
He feels the Fed may be right, with economic growth running at a 3.25% year-over-year rate by the fourth quarter, an environment for stable rates.
"By the year 2000, however, it looks increasingly as though the benign environment of the past few years-strong growth and lower interest rates- will end," the First Union economist said.
Indeed, if the Fed is not propelled toward raising rates, the economy may be soft enough to bring on another reduction of rates, "but only due to rising unemployment," he said.
Mr. Orr himself leans toward this last scenario, "but neither outcome appears pleasant-especially when compared with the great economic conditions of the past few years, which we all have begun to take for granted."