Fed leaves rates alone a 2nd time

View of weak growth as biggest threat to economy is dropped

March 20, 2002|By BLOOMBERG NEWS

WASHINGTON - Federal Reserve policy-makers took a step yesterday toward the first interest-rate increase since May 2000 by dropping their 15-month-old view that weak growth is the biggest threat to the U.S. economy.

Central bankers left the benchmark overnight bank lending rate at a 40-year low of 1.75 percent and said the economy is recovering from a recession that started a year ago. It was the second time the Fed's policy-setting Open Market Committee has decided to hold rates steady after 11 straight rate reductions last year.

"The information that has become available since the last meeting of the committee indicates that the economy, bolstered by a marked swing in inventory investment, is expanding at a significant pace," the Fed said in a statement announcing its decision. The vote was unanimous, the Fed said.

Some borrowing costs for businesses and consumers might rise in expectation of a Fed rate increase in coming months. The yield on the benchmark 10-year Treasury note, to which many residential mortgages are tied, has climbed more than a quarter of a percentage point since Fed Chairman Alan Greenspan told Congress on March 7 that the recovery was "well under way."

After the announcement, the Treasury's 4.875 percent note that matures in February 2012 rose 0.0938 point, pushing down its yield a basis point to 5.28 percent. A basis point equals 0.01 percentage point.

In it's statement, the Fed called the overnight rate "currently accommodative." That is a sign that policy-makers view rates as too low for the longer term but aren't ready to move another step toward a rate increase, analysts said.

"This is the first step toward an eventual tightening of monetary policy," said Bruce Steinberg, chief economist at Merrill Lynch & Co. Inc. "The Fed remains somewhat cautious, although the economic data show a strong start to the recovery."

The economy's rebound from recession has surprised economists and Fed officials.

The gross domestic product expanded at a faster-than-expected 1.4 percent annual rate in the final three months of last year. Manufacturing grew in January and February for the first time in a year and a half. The economy added jobs in February for the first time since July as the unemployment rate fell a second straight month.

With evidence that the economy is growing and few signs that inflation is picking up, the Fed took yesterday what analysts call a "neutral" stance toward interest-rate changes.

"Against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are balanced with respect to prospects for both goals," the Fed statement said.

Investors are expecting the Fed to push up the overnight rate by a percentage point or more this year, starting at its next meeting in May.

The federal funds futures contract for June, tied directly to expectations for the Fed's May 7 meeting, has an implied yield of 1.96 percent, almost a quarter point higher than the current rate.

An implied yield of 3.81 percent on December three-month Eurodollar futures suggests that the overnight rate might rise as high as 3 percent by the end of the year.

One element of the economy that has surprised Fed officials - and led them to expect growth and tame inflation - is productivity.

The Labor Department's measure of how much work an employee performs in an hour grew at a 5.2 percent annual rate in the fourth quarter, after a gain of 1.1 percent in the third quarter.

"One cannot help but be impressed with how well productivity has held up in the face of the abrupt slowing of the economy in late 2000 and in 2001," Greenspan said.

The Fed's decision to alter its policy stance in effect ends the most aggressive rate reductions in Greenspan's 14-year tenure as Fed chairman. Beginning with an emergency rate cut Jan. 3, 2001, central bankers lowered the target rate for overnight loans between banks by a total of 4.75 percentage points last year to combat the economy's weakness.

The overnight rate is lower than it has been on average in any month since July 1961. It averaged almost 5 percent during the record U.S. expansion from 1991 to 2000.

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