Fed takes hands-off approach to rates As expected, figure holds steady at 5.5%

THE BALTIMORE SUN

WASHINGTON -- The Federal Reserve yesterday left the overnight bank lending rate unchanged at 5.50 percent, extending its experiment to see how fast the economy can grow and how low unemployment can go before it steps on the brakes with higher borrowing costs.

Stocks and bonds rose on the news, even though it was widely expected, as investors bet the Fed may not need to raise rates for months to come. "You can't even find inflation under a microscope, so what's the rush?" asked James Glassman, senior economist at Chase Securities Inc. in New York.

Growth slowed to 2 percent or less in the quarter ended on Monday from a torrid 5.9 percent annual rate in the first quarter, analysts said.

The question facing Fed officials is whether the economy will snap back to a growth rate of 3 percent or higher in the second half, which would increase the odds of an eventual interest-rate increase.

Still, even that's not a clear call because of the positive price news. Producer prices fell for the fifth consecutive month during May and consumer prices rose only 0.1 percent, suggesting that companies are finding ways to cope with higher labor costs without raising prices -- no matter how fast the economy is expanding.

Fed policy-makers also left the federal funds rate on overnight bank loans unchanged at their last meeting May 20 -- after the nation's unemployment rate fell to an almost 24-year low and has declined further since then. "They're pushing the limits of traditional monetary policy to see if times have indeed changed," said Bill Cheney, chief economist at John Hancock Financial Services in Boston.

The Dow Jones industrial average rose 73.05 points to close at 7,795.38, with most of the almost 1 percent gain coming after the Fed announcement.

The benchmark 30-year Treasury bond also extended an earlier gain and rose 13/32, pushing down its yield more than 3 basis points to 6.71 percent. The yield on three-month Treasury bills, which are much more sensitive to Fed actions, fell more than a basis point to 5.22 percent.

The Fed could opt to raise rates at its next meetings Aug. 19 or Sept 30 if the economy goes on another growth spurt. As of now, investors see the Fed standing pat, based on trading in Eurodollar futures and other money market interest rates.

The Federal Open Market Committee last raised rates at its March 25 meeting. The Fed justified that quarter-point increase -- the first in two years -- by citing "persisting strength in demand, which is progressively increasing the risk of inflationary imbalances developing in the economy."

Recent reports suggest the economy has shifted into a lower gear. The Commerce Department reported yesterday that orders placed with U.S. factories declined a larger-than-expected 0.7 percent in May after a 1.4 percent gain a month earlier. Strikes at automakers and weak auto sales played a role, analysts said. That followed a decline reported yesterday by the National Association of Purchasing Management in its June manufacturing index.

Retail sales also declined in April and May, claims for state unemployment benefits are creeping higher, construction of new single-family homes slowed from last year, and analysts are warning corporate earnings could fall short of expectations.

With evidence that the economy is slowing on its own, "it would be difficult to justify a hike in interest rates before Congress," when Fed Chairman Alan Greenspan delivers his semi-annual Humphrey-Hawkins testimony in less than three weeks, said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis.

Pub Date: 7/03/97

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