Wells Fargo economists expect steady economic growth next year, despite a slowdown in house-price increases, and rising oil prices and Fed rate increases.

Wells Fargo senior economist Scott Anderson said, “a housing price slowdown, in part triggered by the Federal Reserve’s policy actions, will become more pronounced as the year 2006 progresses, placing consumer spending, credit-quality, and job creation at some risk. The challenges are mounting for U.S. consumers, restricting their ability to spend.” Anderson also said that, “real earnings are being squeezed by the spike in inflation, job growth will remain subdued and energy prices elevated, home equity borrowing and wealth creation from the housing market will dry up.”

Anderson said rising mortgage rates will finally begin to weigh more heavily on housing demand, while rising inventories, slowing sales, and fading builder confidence suggests that housing supply isn’t as tight as it once was. The main risk for the economy next year is the extent to which the housing market downturn could dampen consumer spending, credit quality and job creation, according to the Wells Fargo announcement.

Home equity extraction has single-handedly offset the negative economic effect of a doubling in oil prices in less than two years, but this is not likely to be repeated in 2006, Anderson also noted in the Wells Fargo announcement.

Meanwhile, Jim Paulsen, chief investment strategist at Wells Capital Management, said, “Consumers are stepping aside and manufacturing and other business sectors are stepping in. The U.S. business sector is looking very healthy, and this will help alleviate the slight slowdown in consumer spending and housing. I believe we’re in the early stages of what will be considered a ‘manufacturing renaissance period’ in the next several years that’s tied to steady trade improvements. We’re also seeing renewed strength in the stock market, and foreign economic growth is accelerating, which further positions the U.S. economy for a more sustainable recovery.”

The Wells Fargo’s 2006 Economic Outlook also forecast:

  • Inflation and GDP Growth: The Fed is expected to “win the war on inflation at the expense of modestly slower GDP growth next year,” Wells Fargo economists reported. Anderson said he expects the Fed to increase the funds rate to 4.75 percent by March 2006 and will hold that rate steady throughout the rest of the year. He said consumer and bond market inflation expectations have dropped by about a half of a percentage point since the recent hurricane-induced energy-price spike.

  • Consumer Spending: According to Anderson, a consumer-spending binge has triggered a swell in consumer debt burdens, and a record trade deficit. Anderson forecasts a 3.1 percent growth rate in consumer spending next year, down from 3.6 percent in 2005.

  • Investments: For investors, the news is good. Paulsen said stock prices will likely rise to higher levels and he sees good profit trends, investment liquidity and relatively attractive valuations. However, he said bond yields still have a long way to go to reach the peak of their cycle — we will likely see a 10-year Treasury yield at 6 percent next year, according to the announcement.

  • Global Economy: The economists agreed that foreign economic growth is accelerating, with several foreign markets in the midst of a boom, and the U.S. economy has a good chance of catching up.

  • China: The current Chinese exchange rate policy, though designed to stimulate capital investment in the country, is undervalued and has the potential to create a “worldwide production glut” which could disrupt the global economy, said Aleman. “This is already a problem in the automobile industry and may become a serious problem for other industries,” according to the announcement.

  • Mexico: Aleman said he expects the Mexican economy to grow over the next year.

  • Manufacturing: This sector remains dynamic and will continue to benefit Texas border towns. However, the Mexican economy could be thrown off if the U.S. stiffens its immigration policies, Wells Fargo experts said.

  • Europe: The European market is showing signs of life and the significant currency weakness against the Euro could affect U.S. trade, Paulsen added.

“Unlike previous decades, the recovery of today’s U.S. economy depends on what is happening in the global economy,” said Wells Fargo senior economist Eugenio Aleman. “This makes the current recovery much more sustainable and less vulnerable than it was in the past.”

Wells Fargo & Co. is a financial services company with $453 billion in assets, providing banking, insurance, investments, mortgage and consumer finance to about 23 million customers from more than 6,200 stores and the Internet (wellsfargo.com) across North America and internationally.

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