Negative forces will keep short-term interest rates low

Tuesday, March 18th 2003, 12:00 am
By: News On 6

WASHINGTON (AP) _ The looming war, job losses and higher energy prices will lead Federal Reserve policy-makers to keep short-term interest rates at decades-low levels, analysts said.

All these negative forces are hurting an already fragile economy and causing consumers and businesses to become even more cautious. That's slowing the economic recovery and rekindling fears that the country might slide into a new recession.

``The economy may be petering out,'' worried Richard Yamarone, economist with Argus Research Corp.

To rescue the economy from the 2001 recession and fallout from the terrorist attacks, the Fed has already reduced a key interest rate _ the federal funds rate _ to a 41-year low of 1.25 percent. The funds rate is the interest banks charge each other on overnight loans and is the Fed's main lever to influence economic activity.

The Fed last cut the funds rate on Nov. 6 by half a percentage point.

Some economists believe Federal Reserve Chairman Alan Greenspan and his Federal Open Market Committee colleagues will continue to hold the funds rate at the current, super-low level at their meeting, which got under way Tuesday morning.

Others believe the Fed will cut the funds rate by a quarter-point. An afternoon announcement was expected.

Leaving borrowing costs low or reducing them further might motivate consumers and businesses to spend and invest more, giving a boost to economic growth, economists said.

Still, they are still predicting lackluster economic growth in the coming months.

The economy grew at a tepid 1.4 percent rate in the final quarter of 2002. Some economists believe growth in the current quarter hasn't been much better _ 1.5 percent or higher _ and they've downgraded forecasts amid a worsening business climate. For the second quarter of 2003, some analysts foresee a 2.5 percent growth rate, still below normal performance.

Especially unsettling to analysts was a recent report showing the nation's unemployment rate rose to 5.8 percent as the economy lost a whopping 308,000 jobs during February. Economists believe the jobless rate probably will move higher in the coming months, another factor that could further spook consumers.

``The economy continues to be on a very erratic course,'' said Lynn Reaser, chief economist at Banc of America Capital Management.

A government report Tuesday raised new questions about the continued strength of the residential construction market, one of the few bright spots for the economy.

The number of new housing projects builders broke ground on in February plunged by 11 percent, the sharpest decline in nearly a decade, as bad weather and an uncertain economic climate took its toll on the residential construction market.

Political analysts generally agree that voter concern about the economy contributed in large part to the first President Bush's loss to Democrat Bill Clinton.

President Bush, mindful of the political price his father paid in 1992 for a weak economy, has offered a plan made mostly of tax cuts to help energize the recovery.

If the Fed were to cut the funds rate, commercial banks' prime lending rate _ a benchmark for many consumer loans _ would drop by similar quarter-point to 4 percent. The prime rate moves in lockstep with the funds rate.

Economists who believe the Fed will hold the funds rate steady gather that the central bank will want to see how a war with Iraq unfolds, closely monitoring its effect on the economy.

``This is not business as usual. This is business as unusual,'' said Stuart Hoffman, chief economist at PNC Financial Services, who believes the Fed will hold off on an immediate rate cut.

Other economists believe a war is a foregone conclusion and the Fed might as well reduce rates now. Once war breaks out, consumers _ the lifeblood of the economy _ are expected to initially trim spending. A rate reduction might persuade them not to cut back as much, economists said.

``It would provide a much-needed confidence booster,'' said Yamarone.

If the Fed doesn't cut rates Tuesday, both camps agree the central bank would probably send a signal that it stands ready to lower rates again.

Economists believe the Fed will change the wording of its statement designed to foreshadow future rate moves from the current neutral position to one stating that economic weakness poses the greatest threat to the economy.

Such a move would make it easier for Greenspan to cut rates between meetings through the use of an emergency telephone conference, the procedure the Fed last used immediately after the Sept. 11, 2001, terror attacks. Fed policy-makers do not have another rate setting meeting scheduled until May 6.