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Fed waits for war before changing rates

Wednesday, March 19, 2003

WASHINGTON -- With looming war making economic forecasting unusually difficult, the Federal Reserve decided Tuesday to leave interest rates unchanged at a 41-year low.

Federal Reserve chairman Alan Greenspan and his colleagues held out the prospect, however, that they would move quickly to cut rates if fallout from military conflict should threaten to push the country back into recession.

The Fed's decision to leave its target for the federal funds rate unchanged at 1.25 percent disappointed investors who had been hoping the Fed would cut rates again, driving the funds rate to 1 percent or lower, a level last seen when Dwight Eisenhower was president.

Stocks, surging in recent days over hopes of a quick and successful war against Iraq and a possible Fed rate cut, momentarily lost altitude after the Fed's afternoon announcement. However, the Dow Jones industrial average managed to finish the day up 52.31 at 8,194.23, extending a rally that has added a stunning 670 points to the blue-chip average over the past five trading days.

Many investors had been hoping that if the Fed did not cut rates, it would at least change the portion of its statement designed to foreshadow future moves. They had expected a move from a statement that risks were equally balanced between inflation and economic weakness to a statement that cited economic weakness as the greater threat.

Cloud of uncertainty

Instead, for the first time since it began releasing a "balance of risks" assessment in early 2000, the Fed said the "unusually large uncertainties clouding the geopolitical situation" made it impossible to determine where the risks stood.

The 12-member Federal Open Market Committee, composed of Fed board members and regional Fed bank presidents, said it would engage in "heightened surveillance" of economic developments in coming weeks, a phrase analysts read as a clear signal that the central bank won't wait until its next meeting May 6 to cut rates further if necessary.

"The Fed will pull out all the stops if there is a threat of a double-dip recession," said economist David Jones. He predicted a rate cut could come as early as mid-April if the economy were to weaken further.

There have been a string of reports in recent weeks indicating the economy, which endured a stop-and-go recovery through 2002, was slowing in recent weeks under the impact of rising oil prices and business and consumer jitters about a possible war in Iraq.

Fed officials called the flow of economic statistics since their last meeting in late January mixed but attributed much of the problem to geopolitical uncertainties including the rise in oil prices as traders worried about possible supply disruptions.

The Fed said as those uncertainties lift, the current environment of low interest rates and strong gains in productivity should be enough to spur stronger economic growth.

That was Greenspan's message in congressional testimony last month when he said President Bush's new round of tax cuts probably would not be needed to boost the economy once the uncertainties surrounding Iraq lifted.

Stuart Hoffman, chief economist at PNC Financial Group, said Fed policy-makers still believe, "If we get the war and high oil prices out of the way, the economy can probably improve without any additional rate cuts."

The Fed last cut rates on Nov. 6, reducing the funds rate for the 12th time since January 2001 when it launched an aggressive rate cutting effort to deal with the looming 2001 recession and then the economic shocks from the terrorist attacks and stock market turmoil stemming from a series of corporate accounting scandals.

In addition to pushing the federal funds rate all the way to zero if necessary, economists predicted that the Fed would take other actions if needed such as directly buying long-term Treasury securities to make sure that the financial system has enough money and the U.S. economy is not caught in the deflationary trap that has ensnared Japan.


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