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Fed signals rates may rise in future

©Associated Press
March 20, 2002

WASHINGTON -- Americans can enjoy some of the lowest interest rates in four decades a bit longer. The Federal Reserve passed up a chance Tuesday to raise rates on loans but put the country on notice to expect increases sooner rather than later.

In their most optimistic comments on economic revival, Federal Reserve Chairman Alan Greenspan and his colleagues said recent data indicated the economy was 'expanding at a significant pace.'

Because of that, the Fed changed the wording of the portion of its statement that signals possible future activity away from one tilted toward misgivings about economic weakness. That means the Fed now sees an equal balance in future risks between economic weakness and inflation.

Analysts saw this wording switch as the Fed's first step toward rate increases as the rebound from the country's first recession in a decade gains momentum.

'The Fed is telling us that the recovery is under way, so we have to start working on controlling inflation,' said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

Wall Street took the prospect of future rate increases in stride. The Dow Jones industrial average, up more than 90 points earlier in the day, remained in positive territory after the Fed's midafternoon announcement. The Dow finished the day up 57.50 at 10,635.25.

Economists were split on when Fed rate hikes might start. Some predicted an initial quarter-point increase as early as the Fed's next meeting, May 7.

Others said the rate increases probably will be delayed until the June meeting or perhaps the August discussions, depending on when the unemployment rate peaks and starts to come down.

The recession, which began in March 2001 and was exacerbated by the September terror attacks, pushed the jobless rate to a high of 5.8 percent in December. Unemployment has declined for two months to 5.5 percent in February, but many economists still believe the jobless rate will start rising again and peak around 6 percent during the summer.

'If the unemployment rate edges up during the next couple of months, as seems likely, the Fed probably won't tighten until August,' said Bruce Steinberg, chief economist at Merrill Lynch, saying it would be politically touchy for the central bank to start raising rates to slow the economy as unemployment increased.

The Fed's decision Tuesday left its target for the Fed funds rate, the interest that banks charge each other, at a 40-year low of 1.75 percent, where it has been since Dec. 11.

The central bank aggressively cut interest rates 11 times last year in an effort first to prevent a recession and then to guarantee a speedy recovery.

The series of Fed actions pushed commercial banks' prime lending rate, the benchmark rate for millions of consumer and business loans, down to the current level of 4.75 percent, the lowest since November 1965.

Many economists expect the Fed will move in a series of quarter-point hops to raise rates once it begins tightening credit as a way to make sure the economy does not overheat and create inflation problems.

By the end of this year, many analysts predict the funds rate to rise from its current 1.75 percent to around 3 percent, indicating as many as five quarter-point moves.

However, analysts said that long-term rates probably will not move as much, in part because they already have increased from their lows of last year in anticipation of Fed actions. Freddie Mac's nationwide average for 30-year mortgages is back above 7 percent, after hitting a low of 6.45 percent last year.

The Fed for the first time in its brief announcement gave the vote for Tuesday's decision, which showed that all 10 voting members of the central bank's Federal Open Market Committee agreed to leave rates unchanged but shift the 'balance of risks' statement to neutral.

The announcement marked the latest move by the Greenspan Fed to a position of more openness. The Fed began only in 1996 announcing immediately after its meetings whether it had changed the funds rate.

In Tuesday's statement, the Fed said, 'The economy, bolstered by a marked swing in inventory investment, is expanding at a significant pace.'

It added that 'the degree of the strengthening in final demand over coming quarters, an essential element in sustained economic expansion, is still uncertain.'

Greenspan, while declaring the recession over in a recent congressional appearance, cautioned that the economic recovery is likely to be modest in the early going because of lack of pent-up consumer demand.

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