Economic Sunshine, With a Chance of Rain : Forecast points upward, but interest rates cause worry

California, finally, appears to be joining the rest of the nation in an economic recovery. The state is three years behind, but job gains and an uptick in the housing market are putting it on a recovery track, albeit a slow and perhaps fragile one.

That’s the latest assessment from the UCLA Business Forecasting Project, which for each of the last few years has had to report the gloomy prospect of a prolonged economic slump--California’s worst since the Great Depression. The prominent forecasting group said earthquake reconstruction and the national recovery are helping to put people back to work.

For the first time since 1990, UCLA said, Californians have reason to expect an increase in jobs, incomes, retail sales and construction.

Payroll jobs rose in January and February, the first increase in two consecutive months since mid-1990. Sales of existing houses are up about 20% from a year ago, while business failures are down. Those trends, project officials say, are expected to continue in California and the rest of the nation.

However, clouding the promising outlook is a new uncertainty--abruptly rising interest rates and a plunging stock market (although some correction in stock prices was expected).

The impact of sharply higher interest rates is especially worrisome in California, where higher cost of borrowing could make homeownership unaffordable and could slow job growth.

The Federal Reserve has twice in the last month nudged up its short-term interest rates as a preemptive strike against inflation. The goal was to stabilize long-term interest rates. Few argued with that notion, but the market has rebelled in an unexpected furor.

Yields on 30-year Treasury bonds have shot to above 7%. That in turn is pushing consumer interest rates for home loans to above 8%. Even Federal Reserve Chairman Alan Greenspan must be puzzled at the seemingly irrational market reaction.

Larry J. Kimbell, director of the UCLA Business Forecasting Project, said the rising interest rates represent a concern that could blow the UCLA forecast out of the water. “The bond market is worried about something we don’t see. It is overreacting. If it stays at these rates, our forecast could be wrong and that would mean a whole big difference for California.”

If mortgages hold at 8% or rise higher, that would put homeownership out of financial reach for many--too many. And that would set back the California housing recovery during the spring, the very time when the most houses go on the market.

What the Federal Reserve must consider fully is the possibility that at this delicate stage of recovery too much action to quell inflation might result in unintended consequences--such as stalling the economic revival, especially here in California.

Officials of the Fed are right to worry about the threat of roaring inflation, although price increases appear contained now. But it would be wise to allow the recovery to gain more momentum before further weighting with higher short-term interest rates. Even if the markets settle down, a decent interval with no Fed intervention may be salutary. As it is so often in life, timing is everything.