Fed panel rejects another rate rise Decision indicates view that slowdown will avert inflation

THE BALTIMORE SUN

The stewards of the nation's money supply passed up a chance to raise short-term interest rates yesterday, apparently deciding that the economy is slowing enough to avoid overheating and inflation.

The Federal Reserve's policy-making committee left the funds rate, which banks charge each other for overnight loans and which controls the spigot on the money reservoir, at 5.5 percent. As usual, Fed officials didn't comment.

The freeze surprised many economists, who expected the economy's steaming performance in the first quarter to prompt the Fed's second rate rise this year. Two months ago, the Fed cranked the funds rate from 5.25 percent to its present level.

But recent reports of deceleration in industrial production and especially in retail sales suggest that the economic growth is subsiding and, with it, the inflationary forces that the Fed tries so hard to bottle up.

"One, they were not seeing any evidence that inflation was accelerating," said Lynn Reaser, chief economist at Barnett Bank in Jacksonville, Fla. "Second, their view was that the economy had experienced some temporary factors pushing up growth in the first quarter and that there were signs of slowing in the second quarter."

The inaction pleased investors, who drove up stock and bond prices. After falling more than 75 points earlier in the day, the Dow Jones industrial average reversed course and rose 74.58 points, closing at 7,303.46. The yield on the Treasury's main 30-year bond fell to 6.90 percent from 6.92 percent Monday.

Higher interest rates often erode stocks' value by raising corporate borrowing costs and crimping consumer spending. And they hurt bonds by allowing new money to be lent at prices higher than those commanded by existing notes.

The Fed panel with its finger on the rate trigger, the Open Market Committee, meets again in July. Many analysts, refusing to believe that momentum from the first quarter is truly spent, still expect a rate rise then.

"We still believe that the Fed will tighten once more this year," said Bruce Steinberg, chief economist for Merrill Lynch & Co. in New York. "At this point, we would look to a tightening" in July.

Less of a risk

But others think that current economic growth is equaling April's slower pace. And they also believe that yesterday's inaction is evidence that Fed Chairman Alan Greenspan is starting to buy arguments that inflation is less of a risk than it used to be.

"By our forecast, no, they won't have some reason to tighten in July," said James Annable, chief economist for First Chicago. "By our forecast, they stay on the sidelines over the balance of the year."

The U.S. economy expanded at a 5.6 percent annual rate in the first quarter, its fastest pace in nearly a decade and far beyond what analysts expected. When the Commerce Department announced the result last month, many thought a Fed move in May would be automatic.

But retail sales fell 0.3 percent for April, a subsequent report showed. March retail sales were revised downward. Factory activity slowed. And Labor Department reports continued to show that the worsening inflation that typically accompanies economic expansion is nowhere to be seen.

The economy is in its seventh straight year of expansion, a time in the business cycle when price pressures have historically been high. Yet consumer prices edged up just 0.1 percent in April. And producer prices -- another key inflation gauge -- plunged 0.6 percent in April, the largest drop since 1993 and their fourth straight monthly decline. For the first four months of 1997, producer prices have fallen at a 4.0 percent annual rate.

A report last week that housing construction perked up in April apparently didn't dissuade the Fed from an interpretation of a slowing economy. Neither did April's unemployment rate of 4.9 percent, a 23-year low that some economists said was temporary.

"It was a genuinely hard call," Annable said. "Had the meeting been a month ago, they would have done it. But the evidence of a slowdown really started to accumulate."

3-point spread

The funds rate is half a point below its decade high of 6.0 percent, reached in February 1995. The rate got as low as 3.0 percent in 1992, when the U.S. economy was struggling and the Fed wanted to infuse a shaky banking system with cheap money.

The funds rate is now about 3 percentage points above the rate of inflation; a 2-point spread is typical.

Even if predictions of a slowdown are correct, the economy is still likely to grow by 2.0 or 2.5 percent in the second quarter. That's close to what analysts once thought of as the economic speed limit -- the growth rate where inflation starts to become a problem.

But many analysts increasingly think that inflation is being contained by new forces such as global competition and accelerating productivity improvements. In such an environment, they believe, the Fed can leave its foot off the brake and let the economy grow at a faster rate.

Pub Date: 5/21/97

Copyright © 2021, The Baltimore Sun, a Baltimore Sun Media Group publication | Place an Ad
45°