Posted on: Tuesday, May 14, 2002

Fed may hold rates steady through 3rd quarter

By Jeannine Aversa
Associated Press

WASHINGTON — With inflation under wraps, the Federal Reserve has the luxury of waiting until the third quarter or even later to begin boosting short-term interest rates, many economic forecasters say.

In its quarterly economic outlook, the National Association for Business Economics reported that 73 percent of forecasters surveyed expect the Fed to start raising rates in the July-September quarter and 13 percent thought it would be sometime after.

However, another 13 percent predicted Fed policy-makers will begin moving rates higher before the end of June. The Fed's next meeting to discuss interest-rate policy is on June 25-26.

Citing uncertainties about the unfolding economic recovery, the Fed last week decided to leave the federal rate — the interest that banks charge each other on overnight loans — at 1.75 percent, the lowest level since July 1961. It marked the third time this year that policy makers decided to hold rates steady.

The decision meant the prime lending rate — a benchmark for many consumer and business loans — would remain at 4.75 percent, the lowest level since November 1965.

When asked to define what would constitute "neutral" interest rate policy — meaning it wouldn't be considered at a level aimed at neither reining in or spurring economic growth — the average response was a federal funds rate of 3.5 percent — double the current rate.

Two-thirds believed the Fed could wait until April 2003 or later to push interest rates up to the

3.5 percent mark. Less than 25 percent thought Fed policy-makers should strive for a 3.5 percent funds rate this year.

The prime rate moves in lockstep with the federal funds rate. Thus, a 1.75-percentage-point increase in the funds rate would boost the prime rate to 6.5 percent.

The survey was based on forecasts made by 30 of the association's 3,000 members in the last week of April and the first week of May.

Forecasters expect the economy — which expanded at an anemic 1.2 percent rate for all of 2001 — will grow at rate of 2.8 percent this year.

The economy's weak spots — weak profits and business investment — should rebound next year, forecasters predicted.

"Even though we expect economic growth to average just above 3.5 percent through the end of 2003, little acceleration in inflation is likely," said Harvey Rosenblum, NABE president and senior vice president and director of research at the Federal Reserve's Dallas regional bank.

That's because forecasters are bullish about productivity gains, which allow the economy to grow faster without triggering inflation.

Productivity — the amount of output per hour of work — soared at an 8.6 percent rate in the first quarter, the best performance in 19 years.

"The remarkably good behavior of productivity during the recession taught us one important lesson. Those outsized efficiency gains of the late '90s were not a cyclical or statistical fluke," Rosenblum said.

In general, productivity tends to rise strongly when the economy is booming. But gains in productivity can become weak or productivity can fall when the economy slows or contracts. For all of 2001, productivity grew by 1.9 percent, a slowdown from the 3.3 percent gain posted in 2000, but still a respectable showing given the slump.

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