Fed seen as staying course

Jeannine Aversa

Wednesday, June 26, 2002 | 10:01 a.m.

WASHINGTON -- With the economic recovery losing steam, Americans can expect to see short-term interest rates -- now at 40-year lows -- stay that way through the summer.

That might motivate consumers to spend and businesses to step up investment in new plants and equipment, which would bolster economic growth, economists said.

The notion that Federal Reserve policy-makers are likely to hold rates steady was reinforced by a report Tuesday showing consumer confidence fell in June to a four-month low. The Conference Board, which calculates the index, said confidence was hurt by accounting scandals and worries about jobs.

"For the Fed, declining confidence is just another reason to stand pat, as if they were really looking for one," said economist Joel Naroff of Naroff Economic Advisors.

Recent economic reports suggest the recovery is slowing. Some economists believe economic growth, as measured by the gross domestic product, will clock in at around 2.5 percent in the current quarter, down from the brisk 5.6 percent pace posted in the first three months of the year.

Consumers, whose spending accounts for two-thirds of all economic activity, have shown less vigor recently. Sales at the nation's retailers were down 0.9 percent in May, the largest drop in six months, though unusually cool weather was a factor chilling shoppers' appetites.

Still, low mortgage rates and solid appreciation in housing values, especially given the weak performance of the stock market, continue to motivate home buyers.

New-home sales shot up 8.1 percent in May to a record monthly level of 1.03 million, the Commerce Department reported today.

"I think residential real estate will continue to be a safe haven," said Van Davis, president of Century 21 Real Estate Corp.

Although the unemployment rate dipped to 5.8 percent in May, the jobs market remains sluggish, and economists worry that could dampen consumer spending in coming months.

Manufacturing, after being knocked down by the recession, is back on its feet but isn't bursting with vitality. In another report today orders to U.S. factories for big-ticket items rose 0.6 percent in May.

Capital spending by businesses has yet to turn around, which means a key component to a sustained recovery is lacking, economists said. Deep cuts in spending on new plants and equipment helped push the economy into recession.

Companies that saw their profits take a hit during the slump are worried about the recovery's staying power and are reluctant to make big commitments, in spending or hiring, until they are convinced the turnaround is for real, analysts said.

Some economists worry that violence in the Middle East, tension between India and Pakistan, threats of new terror attacks on the United States and Enron-type accounting scandals will give companies another reason not to make big commitments.

Against this backdrop, economists expect Federal Reserve Chairman Alan Greenspan and his Federal Open Market Committee colleagues to leave the federal funds rate -- the interest that banks charge each other on overnight loans -- unchanged at 1.75 percent, a 40-year low, after their two-day meeting today. An afternoon announcement was expected.

With inflation well-behaved, policy-makers have leeway to keep rates low through the summer to help along the economic recovery, economists said.

Fed policy-makers, who slashed interest rates 11 times last year to rescue the economy from recession, have not changed the funds rate since last December.

If policy-makers continue to hold the funds rate steady, that would allow commercial banks' prime lending rate -- a benchmark for many consumer and business loans -- to remain at 4.75 percent, a level last seen in November 1965.

Some economists are now predicting that the first interest-rate increase would come at the Fed's Sept. 24 meeting at the earliest. Some forecast the first rate increase would come later, in November or December. Others believe there's a good chance rates may be left alone for the rest of the year.