Fed not ruling out more interest rate cuts; analysts believe further reductions not needed

Thursday, January 31st 2002, 12:00 am
By: News On 6

WASHINGTON (AP) _ Most analysts believe the country will not need further interest rate reductions since the economy's vital signs are improving, but the Federal Reserve is leaving open the possibility.

Hours before the Fed announced its decision Wednesday to hold rates steady, the government reported the economy grew at a rate of 0.2 percent in the final three months of 2001, after shrinking by an annual rate of 1.3 percent in the third quarter. The news raised hopes among economists that the first U.S. recession in a decade may be ending.

``It's looking very much like the little recession that wasn't,'' said Tim O'Neill, chief economist at Bank of Montreal and Harris Bank. ``If anything, it will be a kinder and gentler one.''

In explaining their decision to leave rates alone after 11 consecutive reductions last year, Fed Chairman Alan Greenspan and his colleagues offered a more positive outlook. ``With the forces restraining the economy starting to diminish ... the outlook for economic recovery has become more promising,'' they said.

That upbeat assessment spurred a rally on Wall Street, with the Dow Jones industrial average closing up Wednesday by 144.62 points.

The Fed's decision left the federal funds rate, the interest that banks charge each other, unchanged at a 40-year-low of 1.75 percent. The Fed's credit easing campaign, one of the most aggressive in its history, began on Jan. 3 last year, with the last rate reduction occurring on Dec. 11.

Commercial banks' prime lending rate, the benchmark for millions of consumer and business loans, has dropped in lockstep with the Fed moves and continues at 4.75 percent, a level last seen in November 1965.

``I think the Fed will hold rates steady through the first half of this year and give the economy's recovery a chance to take hold and provide time to ascertain whether or not the recovery has gained its own momentum,'' predicted Lynn Reaser, chief economist at Banc of America Capital Management.

Even so, Fed policy-makers left the door open to further rate reductions if necessary, saying ``the degree of any strength in business capital and household spending, however, is still uncertain.''

As the economy faltered, businesses responded by sharply cutting spending on new plants and equipment, one of the biggest forces behind the economy's weakness. Economists say capital spending won't really pick up until companies' profits, battered by the economic slump, improve.

Consumer spending, which account's for two-thirds of all economic activity, has held up well even as the country has suffered through a recession that began in March and was jolted by the Sept. 11 terror attacks. Zero-rate financing and heavy discounting has induced people to spend, but many of those incentives are waning, analysts said.

Given this along with expectations the nation's unemployment rate now at 5.8 percent will rise in the coming months, economists said Fed policy-makers will be keeping a close eye on the behavior of consumers.

``We see the Fed as viewing the resilience of consumer spending as hopeful, but not yet conclusive given the potential constraints of more unemployment, lower bonuses and raises, less refinancing and high debt burdens,'' said David Orr, chief economist at Wachovia Securities.

Still, Orr and most other economists don't foresee the Fed cutting rates again this year.

Instead, the Fed's more encouraging economic outlook, along with analysts' expectations that the economy will return to healthy growth rates in the second half of this year, spurred speculation about when the central bank might actually begin raising rates.

Some analysts thought an interest rate increase could come as early as May or June. Others didn't believe the Fed would start raising rates until next year.

``I could see a rate hike as early as May. But there is one big risk that the Fed may want to guard against: another terrorist attack,'' said economist Joel Naroff of Naroff Economic Advisors. Thus, the Fed ``may wait until it sees that the recovery is strong enough to withstand another shock. That could push the increase off a few months,'' Naroff added.