WASHINGTON -- Fresh signs of a vigorous manufacturing sector and rising prices rekindled fears yesterday that the Federal Reserve soon will have to raise interest rates again to check the economy's rapid expansion.
"People are just worrying about the strength in the economy and the sense that there is a revival in momentum," said Susan Hering, an economist with Salomon Brothers Inc.
Analysts predicted that Fed officials may tighten credit again as soon as Friday, when the Labor Department is scheduled to release the September employment report. Virtually everyone is betting that the next move will be a boost in the federal funds rate to 5.25% from the current 4.75%, which has been left unchanged since Aug. 16.
The latest evidence of a strong economy came when the National Association of Purchasing Management said its index for September jumped to 58.2% from 56.2%. The increase was greater than expected as industrial firms continued to report gains in employment, orders, and production.
The index is derived from a survey of purchasing managers throughout the United States, and a reading above 50% is generally taken as a signal that the manufacturing sector is expanding. A reading over 44.5% signals that the economy is turning up.
The bond market was rattled by the report, which contained a rise in the price index component to a six-year high. A sell-off by traders pushed the yield on the Treasury's 30-year bond up to 7.85% at noon from 7.80% early in the day.
The purchasing managers' index for commodity prices jumped to 77.1% from 74.5%, the highest reading since August 1988. Two-thirds of those surveyed said they paid higher prices for a wide range of industrial materials, ranging from apple concentrate to paper, benzene, polyester, solvents, metals, and electric motors.
"Purchasing executives continue to identify the increase in materials prices as a major concern," said Ralph Kaufmann, chairman of the purchasing managers' survey committee and head of procurement for Oryx Energy Co.
The purchasing managers also indicated that plants were still scrambling to fill orders. The September index for order backlogs remained unchanged at 60.5% -- the second highest level since the group began to keep track at the start of last year.
Fed chairman Alan Greenspan and his colleagues are believed to be paying close attention to commodity prices and industrial sector activity in general in assessing the inflation outlook.
The purchasing managers' report, the first unofficial economic report for September, follows a stream of recent government reports that have surprised the bond market with their strength. Last week the Commerce Department said that sales of new single-family homes surged in August despite higher interest rates.
Analysts said it is becoming increasingly apparent that the Fed's five rate increases this year are failing to slow the economy enough to ward off inflation jitters in the bond market. Several said they believed Fed officials have underestimated the strength of the economy and its underlying momentum.
As a result, the view that even more rate increases by the Fed will take place following the long-awaited move to 5.25% in short-term rates is gaining ground. Predictions that Fed officials will eventually have to raise the federal funds rate to 6% next year are common.
"I don't think there's any evidence that we're going to slow down in the fourth quarter," said Russell Sheldon, senior economist with Mellon Bank in Pittsburgh. "These numbers were at a very high level and signal not only continued strength but future strength, and the price report was very disappointing."
Sheldon said Fed officials were overoptimistic about the economy's prospects for slowing this year in response to higher rates. "They overestimated the impact of rising rates on housing and consumer spending, and they underestimated the momentum from capital spending and exports," he said.
The purchasing managers' index for export orders surged to 60.9% from 58.3%, the highest reading in five years, on stronger demand from Europe, Asia, and Canada. Analysts say the improving economies in these regions are likely to continue boosting sales of U.S.-made goods and services.
Moreover, analysts note that next year the budget deficit is likely to stop declining. If so, a major source of drag on the economy this year will be lifted.