WASHINGTON -- Fresh evidence of a strong economy and tighter labor markets reinforced bond market fears of inflation Friday and buoyed expectations that Federal Reserve officials will act soon to restrain growth.

"They have to continue to pull back on the reins. I don't think there is any question they're going to have to continue to raise interest rates further if they're going to get the economy to slow down," said Darwin Beck, managing director for CS First Boston.

The latest evidence that labor markets are heating up came when the Labor Department reported that the civilian unemployment rate fell in October from 5.9% to 5.8%, the lowest reading in four years. Most economists consider 6% to be close to the natural unemployment rate, or the level at which wage pressures start to build.

"Every tick further that the unemployment rate falls has to make policymakers nervous about higher wages and inflation," said Susan Hering, an economist with Salomon Brothers Inc.

Nonfarm payrolls, which the government tracks in a separate survey of businesses, increased by 194,000. Manufacturing jobs, reflecting stepped-up auto production, rose 40,000, and there were broad gains in retailing, officials said.

The figures reinforced the belief that members of the Federal Open Market Committee will tighten credit for the sixth time this year when they meet Nov. 15 by raising the federal funds rate to 5.25% from 4.75%. Expectations are also widespread that officials will raise the discount rate, now 4%, to send a public signal of their tougher stance on credit.

Some analysts said the Fed is under pressure in the bond market, which is now fully priced for a credit-tightening of least 50 basis points, to take short-term rates up a full percentage point.

"The Fed has made the classic mistake of not tightening enough on the upturn in the business cycle, and the bond market will pay the price," said Michael Strauss, chief economist for Yamaichi International [America]. He estimated that U.S. output may race ahead as much as 5% in the final three months of the year -- roughly double the rate that Fed officials say can be sustained without increasing inflation.

Other analysts were less worried. "The Fed is not behind the curve," said Edward Campbell, chief economist for Brown Brothers Harriman & Co. "We've been worrying about inflation for two years, and the fact is that the rate of inflation is at a 20-year low."

Still, there were hints of rising wage pressures tucked away in the October employment report. The bond market did not take kindly to a 0.7% increase in average hourly earnings to $11.24, and the index of aggregate hours worked jumped 1.0%

The combination of longer hours and higher earnings pushed weekly earnings up 1.6%. That in turn suggests personal income and spending will be strong, giving a lift to the economy going into the last quarter of the year, analysts said.

The Labor Department also issued preliminary benchmark revisions to its household employment series that were stronger than expected. The revised figures raised the level of employment in March 1994, by 760,000 jobs, which means that the total number of jobs will turn out to be higher than previously reported when the government issues its final benchmark revisions next July.

David Wyss, senior vice president for DRI/McGraw-Hill, said the preliminary figures suggested that U.S. output was stronger than previously believed. It also may mean that productivity was lower than reported, which means unit labor costs were higher -- something that would add to worries at the Fed, he said.

There were also signs that California, which accounts for a big slice of the total U.S. economy, is starting to revive. The unemployment rate for the Golden State tumbled to 7.7% from 8.3%. As recently as July, the state's jobless rate was 9.0%.

Clinton Administration officials hailed the employment report as more evidence that the economy is on a solid growth path, and they dismissed worries that inflation is heating up, "The Goldilocks expansion continues -- not too cold, not too hot," said Labor Secretary Robert Reich.

Reich and Robert Rubin, head of the president's National Economic Council, told White House reporters that since President Clinton has taken office the economy has created more than five million jobs. "The Republicans who say with a straight face they can do a better job have a record prior to 1992 to run on," Reich said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.