Fed expected to keep interest rates low

WASHINGTON -- Even though U.S. companies are reluctant to hire workers, the economy over the second half of this year is expected to grow at the fastest pace since 1999.

That surprisingly upbeat prospect means that the Federal Reserve will see no need to cut interest rates at Tuesday's meeting, economists believe.

In recent weeks, analysts have kept revising upward their economic forecasts, given a series of favorable government reports. Many analysts now believe the overall economy will expand at rates well above 4 percent in both the July-September period and the final three months of the year.

That would represent the strongest consecutive quarterly growth rates in the gross domestic product since the last half of 1999. It also would be a significant rebound from the 2 percent average rates over the past year.

"We are seeing very clear evidence of a strong pickup in activity this quarter," said Lyle Gramley, a former Fed governor.

and now senior economic adviser at Schwab Washington Research Group, a financial services firm. "The evidence is in so much abundance that it has everybody revising up their forecasts."

Noting that trend, Vice President Dick Cheney told NBC's "Meet the Press" on Sunday, "I think we've turned the corner and we're making significant progress, and that's part of the normal business cycle, as well as the added unusual factors of a national emergency" -- the Sept. 11, 2001, attacks.

Federal Reserve Chairman Alan Greenspan and his colleagues last cut interest rates in June. They pushed their target for the federal funds rate, the interest that banks charge each other for overnight loans, down by one quarter of a percentage point to a 45-year low of 1 percent.

At the time, the Fed's action to lower a key short-term interest rate failed to have the desired impact on the economy. Long-term rates set in financial markets actually rose on the news.

Bond investors were unhappy because the Fed did not cut rates by one-half of a percentage point and did not use unconventional methods, such as direct purchases of long-term bonds, to influence market-based rates.

Hopes for these bolder Fed moves had arisen as a result of the central bank's expressions of concern, beginning in May, about the possibility the economy could face a threat from deflation. The nation last experienced that destabilizing decline in prices during the Great Depression of the 1930s.

Hopes of aggressive Fed easing sent long-term interest rates falling to levels unseen in more than four decades. Rates on 30-year mortgages dipped to 5.21 percent and the benchmark 10-year Treasury note fell to 3.1 percent.

Those rates jumped by more than a full percentage point after bond investors expressed unhappiness with the Fed's misleading signals.

But in recent weeks, long-term rates again have declined as Fed policy-makers have sought to convince markets that they are prepared to leave interest rates at low levels for as long as it takes to guarantee a sustained recovery.

In the statement issued after its August meeting, the Fed said it believed that rates could remain low "for a considerable period."

If the hoped-for rebound does stall anew, analysts said the Fed will not hesitate to cut rates, even dropping the funds rate to zero if necessary to ensure an economic rebound. That possibility was discussed by Fed Governor Ben Bernanke in a September speech that trigged a rally in the bond market.

"The Fed is making a greater effort to communicate more clearly and the markets are understanding the Fed better," said David Jones, president of DMJ Advisors, a Denver-based consulting firm.

It was nearly two years ago that the economy pulled out of a recession. But companies still are laying off workers; this year alone, almost half-million jobs have been lost. For this reason, too, analysts think the Fed will leave interest rates low for a considerable time.

"The Fed is looking at a world where the economy seems to be picking up but there is no evidence of that yet in the labor market," said David Wyss, chief economist at Standard & Poor's Co. in New York.

Analysts believe interest rates will not move until the central bank sees convincing evidence that the jobless rate, now at 6.1 percent, is falling on a sustained basis and companies are finally beginning to rehire workers.

That is not likely to happen soon. The strong productivity gains the economy is experiencing have allowed companies to do more with fewer workers.

As a result, many economists are forecasting the Fed will not raise rates until after the 2004 presidential election, given the Fed's reluctance to take such action close to a White House campaign.

"The message the Fed wants the markets to hear is that the federal funds rate is going to remain low for an extended period," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.