Fed pondering interest rates

Martin Crutsinger

Tuesday, May 7, 2002 | 9:45 a.m.

WASHINGTON -- With unemployment at its highest level in nearly eight years, the Federal Reserve will hold interest rates steady this week and won't start to raise rates until joblessness begins to fall, economists forecast Monday.

On the eve of today's regular meeting of Fed officials to review interest rates, analysts were in widespread agreement that the central bank will not see this as the right time to start boosting interest rates as a pre-emptive strike against inflation.

Last week, the government reported that the unemployment rate climbed to 6 percent in April, the highest level since August 1994.

That report was the most dramatic of a number of indicators showing that the recovery from last year's recession, after surging out of the starting gate in the January-March period this year, was slowing down.

The lackluster data on economic activity, coupled with continued weak earnings reports from corporate America, has battered Wall Street in recent weeks. The Dow Jones industrial average lost another 198.59 points on Monday to close at 9,808.04, its lowest close since Feb. 19.

"We are in the midst so far of a jobless recovery and a profitless recovery. That is a double-whammy on financial markets and the Fed doesn't want to make it a triple-whammy by raising interest rates," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

The central bank's Federal Open Market Committee, which meets eight times a year to set interest rate policies, has not changed rates since last December, when it capped a yearlong easing drive by cutting its target for the federal funds rate, the interest that banks charge each other, to a 40-year low of 1.75 percent.

Banks' prime lending rate, which follows changes in the funds rate, is now 4.75 percent, meaning that consumers and businesses are enjoying the lowest short-term borrowing costs since 1965.

At its last meeting on March 19, the FOMC left rates unchanged but raised expectations of future rate increases by dropping the language it had been using for more than a year that the greatest danger facing the economy was weak growth.

That wording change sparked concerns that with increasing signs of an economic rebound, the central bank was getting ready to start raising interest rates to make sure the stronger growth did not spark inflation pressures.

Some economists at the time said the rate hikes could begin as soon as the May meeting. However, with the spate of weaker-than-expected economic reports, topped off by the sharp rise in unemployment, expectations on when the Fed will begin raising rates have now retreated to August or possibly even later.

The expectation is that the unemployment rate will peak at around 6.5 percent, probably in June or July of this year. While that is up considerably from the 3.9 percent jobless low-point during the 10-year, record-breaking expansion, it is still well below the 7.8 percent jobless rate hit during the 1990-91 recession.

When the Fed does start raising rates, most analysts are not looking for the dramatic half-point changes the Fed was making last year, but rather more deliberative quarter-point moves.

"The Fed doesn't want to slam on the brakes. They just want to take their foot off the accelerator," said David Wyss, chief economist at Standard & Poor's Co. in New York.

For that reason, many economists are forecasting that the low interest rates that consumers and businesses are now enjoying will rise only gradually this year.

The string of weak economic statistics and the view that the Fed will delay its rate increases until at least late summer have helped push mortgage rates down in recent weeks.

The national average for 30-year mortgages in last week's Freddie Mac survey dipped to 6.78 percent, the lowest level in six months, giving home owners who missed out on refinancing their mortgages last year another opportunity.

Many analysts believe that with the Fed moving only gradually to raise short-term rates, 30-year mortgages should still rise only marginally in coming months and will probably be around 7.5 percent by the end of the year.

"There is a lot of uncertainty in the minds of Fed officials about how strong the recovery is going to be this year," said David Jones, chief economist at Aubrey G. Lanston & Co. in New York. "They will be in no hurry to raise rates."