Recent data confirms our expectation of a more moderate rate of economic growth

• As we have forecasted, recent indicators suggest the economy is slowing from its rapid pace in 2005 and H106
• Moderate job creation and firm real personal income gains will support private consumption. Exports and industrial production growth will likely remain solid
• Although we maintain our 2007 GDP forecast of 3.6%, downside risks have increased

The latest economic indicators are consistent with a slowdown in activity and suggest that the economy has downshifted to a more moderate rate of growth. Dallas Fed estimates of job growth indicate that nonfarm employment grew 3.5% saar in the first half of 2006 but slowed to a 2.3% pace in the second half. In January 2007 employment remained flat; we estimate job creation will slow in 2007 to a still solid 1.8% pace. Notwithstanding these trends, the unemployment rate dropped to 4.5% in January, which indicates that the labor market remains tight, particularly in high-skilled occupations and the energy sector. The latter along with solid gains in underlying productivity and lower inflation ??“as energy prices level off in 2007??“ will result in solid real personal income growth.

Although new residential construction has slowed sharply in recent months ??“ single-family permits decreased 14.7% in the 3 months ended in January 2007??“, the most recent home sales data indicates that home demand remains firm. Solid fundamentals: favorable demographics, strong growth of real personal income, and low cost of borrowing, will support the housing sector. We continue to forecast existing home sales to increase 4.1% in 2007. Although Texas exports have slowed down, they remain solid and growth continues to be broad-based. The main drivers, chemicals, petroleum and coal products, and machinery are likely to keep growing steadily, while computers and transportation exports are moderating and will likely continue doing so, led mainly by a weakened demand from Mexico and Canada. We expect industrial production to grow around 3.5% in 2007 as domestic demand slows down.

Recent data is consistent with our expectation of a gradual economic slowdown, and while moderation will be milder than national average, downside risks have increased. We continue to judge that the biggest downside risk is a sharper deceleration in US overall economic activity, with significant second-round effects on world demand and the energy sector. We maintain our base scenario of 3.6% GDP growth for 2007, still almost 1pp above the nation??™s pace.