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Fed Policymakers Leave Rates Unchanged

Economy: State's recovery expected to benefit from decision by Open Market Committee.

August 21, 1996|RALPH VARTABEDIAN | TIMES STAFF WRITER

WASHINGTON — Responding to signs that U.S. economic growth has cooled off substantially from its overheated pace earlier this year, Federal Reserve Board officials left short-term interest rates unchanged Tuesday.

The so-called federal funds rate, which is the rate banks charge each other on overnight loans, thus remains at 5.25%. The decision, which came after a nearly four-hour meeting of the Fed's Open Market Committee, had been widely expected by economists.

"The Fed has been looking for a slowdown in the second half of the year and now it is happening faster than expected," said John Williams, economist at Bankers Trust in New York. "The question is, will the slowdown last?"

The continuation of low rates should ensure that the economic recovery belatedly gaining strength in Southern California will continue unhindered by higher rates.

"It is very positive for California," said Doug Stewart, first executive vice president for Sanwa Bank. "There is a lot of growth that has begun in Southern California. If you had a rise in rates, it would choke off what is still a young recovery."

Economists said they are far from certain that the economy is safe from a rate hike later this year, particularly after the presidential elections in November.

Merrill Lynch economist Bruce Steinberg predicted the Fed will leave interest rates unchanged for the rest of the year, whereas Williams predicted a slight increase.

The Open Market Committee, which consists of the Fed's seven governors and the presidents of five of its 12 regional banks, will meet only twice more this year, on Sept. 24 and Nov. 13, eight days after the presidential elections, to decide the direction of short-term rates. Many experts believe the Fed is traditionally reluctant to take any action on rates shortly before a presidential election for fear of influencing the outcome.

As the economy pushes forward with a combination of full employment and low inflation, the Fed has little room for interest rate errors--despite often conflicting signs of what the economy is really doing. The unemployment rate stands at 5.4%.

As recently as early August, a broad consensus of economists had predicted the Fed would be forced to raise interest rates at its meeting, a consensus that seemed to flip-flop with a series of economic reports.

The indicators of a slowing economy included reports in early August showing that the nation's factories were operating less robustly, industrial production was growing weakly and housing starts were falling.

The question is whether the economy has actually slowed to what economists consider a sustainable noninflationary rate of about 2% annually, following second-quarter growth of more than 4%.

Sung Won Sohn, an economist at Norwest, predicted the economy will grow at between 2% and 2.5% the rest of this year. That is still fast enough to potentially warrant a rate hike, he said.

"The evidence of an economic slowdown is still tentative and inconclusive," Sohn said.

Indeed, income growth remains robust and take-home pay is up 3.5% on average compared with a year ago, Sohn said. If a slowdown has occurred, economic reports would quickly show weakness in jobs and income.

Fed Chairman Alan Greenspan predicted the slowdown during congressional testimony in July, but even then warned that inflation pressures could yet force the Fed to raise rates.

The Federal Open Market Committee last raised rates in early 1995, then cut them in three steps concluding in January.

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