Fed Keeps Rates Steady, Warns of Risks

Published September 24, 2002

| Reuters

Federal Reserve policymakers warned on Tuesday a growing risk of war was heightening uncertainty about the U.S. economy's future, but for now chose to leave interest rates at four-decade lows.

With financial markets buckling under the weight of worries about the economy, the possibility of war with Iraq and rising energy prices, the U.S. central bank's Federal Open Market Committee announced it was maintaining its federal funds rate charged on overnight loans between banks at 1.75 percent. 

However, two members of the policymaking committee -- Dallas Fed President Robert McTeer and Fed Board Governor Edward Gramlich -- called instead for a rate cut in the first departure from FOMC unanimity on rates this year. 

In the 10-2 decision, the Fed said current low rates and strong growth in productivity, or output per worker, should produce brighter business prospects "over time," wording that mirrored the statement after its August meeting. 

The central bank added a new caution on Tuesday, saying rising global tensions were helping keep a damper on U.S. economic prospects. 

At the beginning of this year, most analysts predicted policymakers would be raising rates by now to keep inflation under control, instead of arguing among themselves about cuts. 

But the recovery so far has failed to get a real tailwind and businesses remain cautious about new spending and hiring. 

"Considerable uncertainty persists about the extent and timing of the expected pickup in production and employment owing in part to the emergence of heightened geopolitical risks," the Fed said in a characteristically terse statement. 

The fact that policymakers warned again of the threat of economic weakness potentially foreshadows rate cuts ahead should the situation deteriorate. 

Stock markets fell after the decision to keep rates steady, with some investors disappointed the Fed did not cut borrowing costs and others worried about the anemic pace of corporate profit growth and the possibility of a U.S. attack on Iraq. 

Treasury prices rose as investors apparently fled equities for safer havens. 

War Jitters a New Factor 

Analysts said policymakers clearly felt that war jitters, which have sent global energy prices skyrocketing, were making it more difficult to keep the slow-paced expansion running. 

"From their point of view a geopolitical shock would lead to a significant double-dip risk and they don't want to go down that road," said economist John Silva of Wachovia Securities in Charlotte, N.C. 

The warning about geopolitical dangers was a shift from Fed Chairman Alan Greenspan's statement to lawmakers earlier this month that only a lasting conflict would prove damaging. 

"It (a recession) would surprise me because I don't think that the effect of oil as it stands at this particular stage is large enough to impact the economy unless hostilities were prolonged," Greenspan told the U.S. House Budget Committee. 

The Fed has kept the trendsetting federal funds rate at 1.75 percent all year after cutting it 11 times during 2001. Recent data, including a Conference Board report out earlier on Tuesday showing a fourth straight monthly drop in consumer confidence during September, have fanned fears about the shakiness of the recovery from last year's recession. 

Some on the FOMC clearly felt that more economic tonic was necessary at this stage. 

While McTeer has in the past argued for looser monetary policy, this dissent was Gramlich's first on an FOMC vote since joining the Fed in 1997. McTeer earlier this month expressed concern that the economy wasn't creating enough jobs. 

Greenspan typically seeks consensus from the FOMC members, particularly his fellow Fed Board members, in policy debates. The last time there was any recorded dissent in an FOMC decision was in December 2001 when Kansas City Fed President Thomas Hoenig voted to keep interest rates steady rather than lower them as a Fed majority decided to do. 

Policymakers said the post-meeting statement that data since their last gathering on Aug. 13 have indicated "aggregate demand is growing at a moderate pace." 

"Over time, the current accommodative stance of monetary policy, coupled with still-robust underlying growth in productivity, should be sufficient to foster an improving business climate," the Fed said in wording identical to its Aug. 13 statement. 

Bush Team Steadfast 

The Bush administration has remained steadfast in its belief the economy will not suffer a renewed slump and officials have pounded this message home ahead of November's congressional elections. The Democrats for their part have emphasized the sour turn the economy has taken in President Bush's time in office. 

With elections on the horizon, the Bush team has a big stake in ensuring the economy does not slip back into recession -- in which national output shrinks for at least two quarters. 

Strong consumer spending on new cars and other goods and a buoyant housing market supported by low mortgage rates have kept the expansion moving forward since late last year and helped counter the lack of capital spending by businesses. 

U.S. equities, already enduring the worst bear market in 60 years, were not mentioned by the Fed on Tuesday but some economists fret they could take a bite out of spending. 

A jump in global oil prices, if prolonged, could also weigh on consumers in future. Energy costs have surged as the Bush administration has ramped up its campaign to win global support for unseating Iraq's Saddam Hussein. 

U.S. benchmark crude oil futures climbed on Tuesday to their highest level since February last year. Most analysts have said that energy has not yet grown costly enough, nor the stock market slide steep enough, to derail the expansion. 

In fact, estimates are that gross domestic product, which measures total economic output within U.S. borders, could expand at an annual rate exceeding a respectable 3 percent in the third quarter ending this month. 

The economy grew at an anemic 1.1 percent annual rate during the second quarter.

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