Reserve weighs decision on rates

Jeannine Aversa

Tuesday, Dec. 10, 2002 | 9:44 a.m.

WASHINGTON -- Millions of out-of-work Americans, a bumpy stock market and economic uncertainties are motivation enough for the Federal Reserve to keep short-term interest rates at 41-year lows for a while, economists say.

Leaving borrowing costs low might motivate consumers, the economy's lifeblood, to keep spending and might encourage businesses to increase investment. That would provide a helping hand to an economy that analysts believe will grow tepidly this quarter and in the first quarter of 2003 but will not slide into a new recession.

"The Fed is expected to be sidelined until at least March given the uncertainties and the fragility of the current economic climate," said Richard Yamarone, economist with Argus Research Corp.

Knocked down by last year's recession, the economy has experienced an uneven recovery this year. The seesawing economic growth -- a below-par 1.3 percent pace in the second quarter, rising to a brisk 4 percent rate in the third quarter -- troubles the Bush administration, Fed policy-makers, Wall Street and Main Street.

"The economy is like a car trying to navigate a winter highway. It is moving but at a very sluggish pace and there have been stretches where conditions are quite slow and treacherous," said Lynn Reaser, chief economist at Banc of America Capital Management. "The general view, however, is that road conditions are going to improve in the spring, but until then a weather alert will remain in effect."

The manufacturing sector's comeback trail has hit a pothole. But consumers have been keeping their pocketbooks and wallets sufficiently open to prevent the recovery from fizzling. And low-mortgage rates are expected to power home sales to new records this year.

New claims for jobless benefits recently hit a 21-month low, suggesting layoffs are slowing. Yet the nation's unemployment rate jumped to 6 percent in November matching April's figure, which was the highest rate in eight years. The number of unemployed people rose to 8.5 million in November, up from 8.2 million the previous month.

The higher unemployment rate is fresh evidence that companies, worried about a possible war with Iraq, the stock market and battered profits, are reluctant to make big commitments in hiring and capital investment, thus restraining the recovery.

Against this backdrop, many economists believe Fed Chairman Alan Greenspan and his Federal Open Market Committee colleagues will hold a key interest rate -- the federal funds rate -- steady at 1.25 percent at their last meeting of the year today. Policy-makers began the meeting in the morning and an afternoon announcement was expected.

The funds rate is the interest that banks charge each other on overnight loans and is the Fed's main lever for influencing the economy.

"I think there will be a 1.25 percent funds rate for as far as my forecasting eye can see," said Stuart Hoffman, chief economist at PNC Financial Services Group.

The Fed's first rate cut this year and the 12th since January 2001 came at the central bank's previous meeting, Nov. 6. That bold, half-point reduction pushed the funds rate down to 1.25 percent. In response, some commercial banks' prime lending rate dropped to 4.25 percent.

Were the economy to show new signs of stumbling, some economists said they wouldn't rule out an interest rate reduction at the Fed's first scheduled meeting of 2003, on Jan. 28 and 29. Economists also believe Congress is likely to pass an economic stimulus package next year, taking some pressure off the Fed to reduce rates.

If the economy picks up momentum next spring, as some analysts predict, and that continues to build, economists said the Fed might raise rates late next year.

Economists predict a winter lull. Many think the economy is growing at only a 1.4 percent rate this quarter and they foresee a lackluster 2.5 percent growth rate in the first quarter of 2003.

Given that, economists think the jobless rate could hover around 6 percent in coming months, a potential problem for Bush's 2004 re-election campaign. Economists don't foresee the unemployment rate moving down on a continued basis until late next year.