Economists predict Fed will stand pat on rates

July 05, 1995|By Jay Hancock | Jay Hancock,Sun Staff Writer

Alan Greenspan and his policymaking colleagues at the Federal Reserve lifted short-term interest rates seven times and 3 percentage points between February 1994 and February 1995. Then they sat back and watched.

Many economists expect that the watching and waiting will continue this week. Thanks to a few recent signs of economic strength, they believe it unlikely that the Federal Reserve will loosen credit when its rate-setting panel meets today and Thursday.

"They will probably leave things alone," said Robert Sweet, chief economist at First National Bank of Maryland. "I don't think rates are going to change until the August meeting."

If the Fed's Open Market Committee does anything this week, analysts said, it likely will cut the federal funds rate slightly, from 6 percent to 5.75 percent, leaving the 5.25 percent discount rate unchanged.

"My best guess is they'll either do nothing or they'll go 25 basis points," dropping the funds rate a quarter percentage point, said Terry Rose, managing director at Advisers Capital Management, a New York firm that makes financial bets on rate changes. "The one thing they don't want to take a chance on ever is to see inflation come back up again."

The funds rate is what banks charge each other for overnight loans; the discount rate is charged to banks borrowing directly from the Fed, the nation's central bank.

By raising and cutting the cost of credit for banks, the Fed influences short-term rates generally, the size of country's money supply and the psychology of investors. The idea is to keep rates low enough that the economy can prosper and produce jobs, but not so low that price inflation accelerates and erodes the value of money.

By many accounts, the Fed so far has done a good job of that since the last economic recession ended in early 1991.

The country's gross domestic product, a broad measure of goods and services, grew by a robust 4.1 percent last year and increased at a 2.7 percent annual rate in the first three months of this year. Inflation was just 2.8 percent last year and has stayed subdued in 1995. But many recent indicators have suggested that the economy is braking rapidly. And a growing number of economists -- apparently including some inside the Fed -- believe rates must descend to ensure that the next down-phase of the economic cycle isn't too severe.

The biggest shadow over the economy was news a month ago that the nation lost 101,000 jobs in May, one of every thousand, in the biggest employment erosion in four years. Lackluster showings in people's incomes, retail sales and consumer confidence also suggest that the economy is decelerating.

But there are enough signs of strength that the Fed can hold rates steady this month or ease only slightly and still retain its credibility, economists said. Factory orders have been strong. And economy-watchers were startled last week by a report that new-home sales jumped by 19.9 percent in May, the biggest increase in three years and a sign that lower long-term interest rates are starting to help homebuilders.

Lower long-term rates -- a sign of market confidence in the Fed as an inflation fighter -- are one important factor that could help the economy revive after what many expect to be a flat second quarter. In addition, a lower dollar is spurring U.S. exports, as evidenced by a 20 percent jump in machine-tool orders in May.

Analysts said those developments should help Mr. Greenspan argue against rate doves, such as Fed Vice Chairman Alan Blinder, who might want a substantial easing of credit this week. And the Fed may decide it needs more soundings on the economy -- especially the June jobs report -- before it cranks down rates. The next Open Market Committee meeting is in late August.

"Clearly Greenspan has a strong bias toward price stabilization," said Charles McMillion, president of MBG Information Services, a Washington economic consulting firm. "My betting is they probably won't do anything" this week.

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