Fed expected to hold line on interest rates

By , Staff writer of The Christian Science Monitor

A small additional decline in interest rates could be the eventual result of a meeting today at the Federal Reserve. The Fed's policy-setting Federal Open Market Committee (FOMC) meets eight times a year to survey the economy and decide what steps the nation's central bank should take to influence credit conditions.

Some Fed analysts say the FOMC will opt for a slight easing in credit conditions in the weeks ahead, especially if the economy's current lackluster performance continues.

The latest bit of disappointing economic news came Monday when the government reported that new-home sales fell a surprising 3.8 percent in February, despite a rapid drop in mortgage rates. Other recent signs of weakness include a rise in unemployment and drops in industrial production, retail sales, and factory utilization.

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``We think the Fed is probably disappointed in the most recent crop of economic statistics,'' says Raymond Stone, chief financial economist at Merrill Lynch Economics. As a result the Fed may ``want to take some small action to ensure the economy becomes stronger.''

If the Fed does ease credit conditions a bit, the average person would likely see a modest decline in short-term interest rates, such as those those on Treasury bills. A decline in short-term rates might lead to a further reduction in longer-term rates, including home mortgages, ``as well as a favorable impact on the stock market,'' Mr. Stone says.

Any additional downward drift in interest rates will add to the drop consumers have already seen in what their savings earn. Moreover, beginning today, financial institutions are free to pay whatever rate of interest they wish on passbook savings. The Fed's Regulation Q, which set a ceiling on the level of interest, expired Monday.

Analysts say that due to the recent sharp drop in other interest rates, banks will have little incentive to boost the rates they pay savers. And, they add, if some do raise rates a bit, they may well offset the cost of such a move by increasing the fees imposed on passbook accounts with low balances. There are an estimated 91 million passbook accounts in US banks and thrifts, containing about $305 billion.

Not all Fed analysts say the central bank will make even a slight move toward easier credit. The US economy is not ``urgently in need of monetary stimulus,'' says Jeffrey Leeds, managing director of the capital markets group at New York's Chemical Bank. ``A wait-and-see attitude is what I would expect for the time being.''

Any monetary policy moves the Fed takes today are likely to be subtle, unlike the March 7 cut the Fed made in its discount rate. That is the fee the Fed charges financial institutions for money they borrow from the central bank and usually signals or confirms a major policy shift.

There are several reasons the Fed is not expected to make any dramatic policy moves this week. After a widely publicized internal dispute at the Fed over the latest discount-rate cut, policymakers are eager to reassure financial markets that chairman Paul A. Volcker's anti-inflationary position has support.

The Fed is ``moving toward an easier [credit] policy, but I wouldn't expect another cut in the discount rate until they see another month's statistics,'' says David Wyss, senior vice-president of Data Resources Inc., an economic forecasting firm. This is due in part to what he sees as the Fed's desire to watch for the effect of the March discount-rate cut on the economy.

Analysts say the Fed is also watching to see if the Bank of Japan makes a widely expected cut in its discount rate. And the central bankers are also awaiting the outcome of an April 15 meeting of the Organization of Petroleum Exporting Countries (OPEC), which wants to stem the slide in oil prices.

Says David Berson, senior economist at Wharton Econometric Forecasting Associates, ``What is likely to happen is that [the Fed] will keep policy unchanged but err on the side of supplying more'' to banks.

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