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Reports, Market May Force Fed's Hand

March 17, 2001|WALTER HAMILTON | TIMES STAFF WRITER

Fresh evidence of economic weakness and another swoon in stock prices Friday turned up the heat on the Federal Reserve to dramatically slash interest rates next week.

New reports on industrial production and inflation depicted a sluggish economy that could worsen if stock prices keep tumbling, economists said. The news may be bad enough to convince the Fed to shrug off a report that housing starts, though declining, were stronger than expected last month, and another showing a small uptick in consumer confidence, analysts said.

Until this week, Wall Street was convinced that Federal Reserve policymakers would lower interest rates by a half-point when they meet Tuesday. The Fed cut rates by that amount twice in January.

But Friday's news may coax the central bank into cutting by three-quarters of a point, some economists said.

Fed Chairman Alan Greenspan has been loath to give the impression that he is bailing out investors. But crumbling share prices could cause additional spending reductions by consumers and businesses, potentially bumping a fragile economy into recession.

The Dow Jones industrial average fell 207.87 points to 9,823.41 on Friday, ending its worst week since 1989 and adding to fears that U.S. equity markets are stuck in a long-term rut.

Ten of the 25 bond dealers who trade directly with the Fed now expect a three-quarter-point cut. Before this week, none of them did.

"There's a better-than-even chance of [the larger cut] because of the potential risk from the equity market downturn and the ripple effects" that could follow, said Lynn Reaser, chief economist at Banc of America Capital Management in St. Louis.

On Friday, the Federal Reserve reported that industrial production skidded 0.6% in February, the fifth straight monthly decline. The data cemented the long-held view that the manufacturing sector is contracting as demand ebbs for everything from automobiles to dishwashers.

Separately, the Labor Department said that wholesale prices rose a mere 0.1% last month--another reflection of softening demand for goods. Excluding volatile food and energy, prices actually declined 0.3%--the sharpest drop in 7 1/2 years.

Car prices fell 1.5%, and truck prices 3.6%, the apparent effects of auto maker incentives implemented to spur sales. Computer prices dipped 1.1%.

On the flip side, energy prices rose 1.4%, and food prices moved up 0.6%.

The paucity of price hikes clears the path for the Fed to cut rates without worrying about jump-starting inflation, economists agreed.

Meanwhile, consumer confidence rose moderately in early March, according to a preliminary University of Michigan survey. The index of consumer confidence inched up to 91.8 from 90.6 last month.

After three months of declines, confidence was expected to drop again. But economists said the improvement was minimal, and pointed out that the survey was largely completed last weekend, before this week's broad stock-market decline.

The most encouraging news came from the Commerce Department, which reported that housing starts, though falling 0.4% last month, came in better than expected.

Overall, the housing sector has held up well. But some experts worry that the depressed stock market may upset that scenario by wiping out down payments of potential home buyers.

A rate cut would lower the interest rates that borrowers pay on everything from personal auto loans to corporate lines of credit, thus encouraging spending and investment that would boost the economy.

Nevertheless, many analysts predict only a half-point cut. The Fed has been hesitant to move too aggressively, in part because it fears sending a message that the economy is in dire shape.

Indeed, recent economic data has been mixed. Besides the improved consumer confidence and solid housing data, other statistics have indicated that the downturn may be moderating.

But a half-point cut grows riskier with each drop in the market, experts say. It would almost certainly disappoint Wall Street and perhaps spur another round of selling--a vicious cycle that could further compromise the economy and necessitate more rate cuts.

"Their viewpoint all along has been that, 'If the sky falls, we'll react, but we won't do so until it falls,' " said Ian Shepherdson, economist at High Frequency Economics in Valhalla, N.Y.

*

Bloomberg News was used in compiling this report.

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