Fed's rate plans mulled

Experts say action likely

question is when, how far open-market panel will go

Effect of further easing debated

Panel, meeting this week, expected to at least shift `bias' as economy limps

August 11, 2002|By Bill Atkinson | Bill Atkinson,SUN STAFF

Despite increasing signs that the economy is faltering, economists don't expect the Federal Reserve Board to rush through an interest-rate cut this week. But next month might be a different matter.

At most, economists believe, the Fed's rate setting arm - the Federal Open Market Committee - will shift what is known as its policy bias. Its bias, or leaning, is neutral, which means the Fed is comfortable with the economy and has no plans to either raise or lower interest rates. Economists believe that leaning might change, though, possibly as early as Tuesday's meeting, to focus on a deteriorating economy.

Such a signal would prepare economists, business executives and the markets for more interest-rate cuts, they said.

"I think they will move, but I don't think they are there yet," said Robert D. Hormatz, vice chairman of Goldman Sachs International in New York. "They want to save the limited ammunition they have. I think the probability is very high we will see an easing by the end of the year. The question is when."

Interest rates have been sliced close to the bone with the federal funds rate, which banks charge one another on overnight borrowings, at 1.75 percent, a 40-year low.

Whether the Fed raises or lowers that rate is important because any move ripples through the economy, affecting how much consumers pay for home loans, auto loans and credit cards.

Some economists wonder whether, even if the Fed cuts rates, a reduction would have much effect with rates already low and confidence among business executives and consumers shaken.

For months, the economy has been rocked by business failures, accounting scandals and a plunging stock market. And in the past two weeks, economists have begun urging the Fed to cut deeper. They fear that if the central bank doesn't act soon, the economy will decline even more or perhaps slip back into recession. Most economists think the country emerged from a mild recession at the end of last year or early this year.

"I think it [economy] is going to weaken significantly," said James W. Paulsen, chief investment officer at Wells Capital Management in Minneapolis. "I think we are going to have zero to 1 percent growth in the third quarter."

He said the Fed should make one large cut of as much as a percentage point in the next two months.

"From here in, it is not about making credit cheaper. ... It's to change attitudes and sentiment," Paulsen said.

A number of troubling signs have emerged in the past two weeks. The gross domestic product - a broad measure of the economy's health - grew at an anemic 1.1 percent annual rate in the second quarter, slowing from its brisk 5 percent clip in the first three months of the year.

In addition, consumer confidence slipped last month, manufacturing activity grew more slowly than expected in the same period, companies added only 6,000 jobs to payrolls - one-tenth of what was anticipated - and the average workweek fell by 18 minutes.

Although the decline in the workweek seems insignificant, "you add that up, and it is the equivalent of almost 1 million fewer workers that month," said Ethan Harris, co-chief U.S. economist at Lehman Brothers in New York. "Economists looked at that and said, `Hmm.'"

Harris and Lehman Brothers economist Steve Slifer argue that the Fed should trim the federal funds rate to 1 percent over a three-month period, with quarter-point cuts next month and in November and December. Harris doesn't expect to see a cut this week.

"Even for somebody like us who is fairly bullish about rate cuts ... it seems too early for the Fed to go," Harris said. "The evidence hasn't really reached a critical threshold yet."

Some economists argue that the Fed shouldn't rush to reduce rates because they still see the economy holding its own and eventually improving.

"We had seen steady progress up until the last month," said Sharon L. Stark, chief fixed-income strategist at Legg Mason Wood Walker Inc. in Baltimore. "One month's worth of data does not make a trend."

Stark said she is "guardedly optimistic" about the economy. She sees the Fed cutting rates if consumer spending falls and employment shrinks.

"We may have some forest fires, we may have some drought, but at the end of the day the forest is still green," Stark said.

How big an impact rate cuts would have on the economy is debated. Lower rates would help the auto industry sell more cars by enabling them to continue offering zero-percent loans to consumers, experts said. Lower rates would also help the housing industry sell more homes. But the biggest boost would be psychological, economists agreed.

"It is the Fed saying, `We are here, we are acting, we are trying to get this economy growing again,'" Harris said. "Because it is a psychological thing, it doesn't always work."

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