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Fed Leaves Key Rate Unchanged

The agency cites the softening labor market, apparently hinting at another rate cut if job losses aren't stemmed.

September 17, 2003|Peter G. Gosselin | Times Staff Writer

WASHINGTON — Federal Reserve policymakers voted Tuesday to leave the nation's benchmark interest rate at a 45-year low of 1% and obliquely suggested that they might cut it further if the economy did not generate more jobs shortly.

The policymakers, led by Chairman Alan Greenspan, issued largely the same statement as they did after their August meeting, expressing cautious optimism about renewed growth, worrying about the possibility of deflation and suggesting an intention to keep interest rates low "for a considerable period."

But in a highly visible departure from their earlier assessment, they acknowledged that "the labor market has been weakening." They had previously said that "labor market indicators were mixed." The economy shed a net 93,000 jobs in August, its seventh straight month of losses. First-time unemployment benefit claims reached a two-month high of 422,000 last week, a sign that employers are still cutting payrolls.

"The Fed is disappointed in the job numbers," said Jay Mueller, fixed-income director with Strong Capital Management. "It's very unusual to be this far into a recovery and not have positive job creation."

The disappointment may be especially keen because the weak employment picture follows one of the Fed's most aggressive rounds of rate cuts. At 1%, the federal funds rate, the interest that banks charge each other for short-term loans, is negative when inflation is taken into account and has been so for the better part of two years, analysts say. That means that banks are, in effect, paying other banks to borrow from them.

Most economists think the central bank will maintain rates where they are at least through the end of the year and probably longer unless the job market deteriorates, in which case the Fed will cut rates. Policymakers said Tuesday that low rates were "providing important ongoing support to economic activity."

The decision to hold the funds rate at 1% means that many short-term consumer and business loans will remain at their lowest levels since the late 1950s, an incentive for borrowers to step up spending to take advantage of the cheap money. But it is bad news for senior citizens and others who rely on income from bank accounts and money market funds.

The stock market greeted the Fed's latest decision warmly. The Dow Jones industrial average climbed 118.53 points, or 1.3%, to close at 9,567.34, while the Nasdaq composite index rose 41.55 points, or 2.3%, to 1,887.25 and the Standard & Poor's 500 index advanced 14.51 points, or 1.4%, to 1,029.32.

Just before the Fed's announcement, the Dow was up only 48 points.

On its face, the Fed's latest assessment of the economy seemed markedly darker than that of most private sector economists.

As they have since spring, the policymakers offered a split-screen view of the economy. They said the chances that growth would be stronger or weaker than expected were "roughly equal." They said that the risk of "an unwelcome fall in inflation" was substantially greater than that of a pickup in prices. Most economists think that strong growth is a near certainty, at least for the next year or so, and that the danger of a further fall in inflation or deflation is essentially nonexistent.

Analysts were deeply divided Tuesday about whether the Fed's outlook was actually at odds with that of economists, or whether the policymakers were simply being cautious.

Stephen G. Cecchetti, a Brandeis University economist and former Fed official, said the central bankers saw the weak job market as evidence of considerable slack in the economy that would retard growth more than most private forecasters predict. By contrast, Mueller of Strong Capital said Fed officials expect stronger job growth in time and were being cautious for tactical reasons.

"They don't want to convey that we're off to the races," for fear of driving up long-term interest rates, which the central bank does not control, and stopping the recovery in its tracks, Mueller said.

The Fed, last cut the fed funds rate by a quarter of a point on June 25, its 13th reduction since January 2001. Analysts believe that near-record short-term rates, together with President Bush's third round of tax cuts, have assured that the economy will grow at a sprightly pace during the second half of this year and perhaps beyond. The National Assn. for Business Economics recently predicted growth at a 4.5% annual rate in the current quarter and 4% in the final quarter of this year. If the prediction pans out, that would be the economy's strongest performance in four years.

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