No slowing yet, so Fed may hit harder

Leery of inflation, board may raise interest rates Tuesday a half point for first time in five years.

In a rare stance, members of the powerful Federal Reserve now seem unanimous about what to do with interest rates.

Raise them - again.

As the Fed meets tomorrow, the only question is whether they will go up by a quarter percentage point or a half percentage point.

A half-percent increase would be significant. It would show that the Fed governors have moved away from their incremental approach to trying to slow the economy - and thus ward off inflation - and have adopted a more aggressive strategy.

It would mark the first time since 1995 that the Central Bank has changed rates by more than a quarter percent. A bigger hike will push home mortgages closer to the double-digit mark and affect stock markets around the world.

The one unknown: Will any increase be enough to slow the V-8 US economy?

"We could see a rate rise every FOMC [Federal Open Market Committee] meeting this year and into next year - except maybe October, just before the elections," says Harold Malmgren, a Washington economist.

The Fed wants the American economic engine running at a 3.5 to 4 percent growth rate, not the 5.4 percent annual rate of the first three months of 2000. What it does Tuesday afternoon to try to retard growth will be of interest around the world.

The value of stocks and bonds in many nations could rise or fall by billions if not trillions in a few minutes. Such currencies as the 11-nation euro and the Japanese yen could climb or tumble in value against the dollar by significant amounts.

Even so, when the news does come at approximately 2:15 p.m. in the press room of the Treasury Department, there will be no press conference. Fed Chairman Alan Greenspan, often called the world's most powerful economic leader, will not say boo. Reporters will simply scramble for a one-page release transmitted several blocks from the marbled palace of the Fed, where the 12 voting governors and regional bank presidents make the decision.

In London, J. Paul Horne, a European economist with Salomon Smith Barney Inc., a brokerage house, will be sitting at a desk, waiting for the news to flash across the screen. It will be 7:15 p.m. there. In Frankfurt, Jrgen Pfister, director of economic research at Commerzbank, will hang around the office for the news.

Why the worldwide interest?

The US, Mr. Horne notes, has an "overpowering economy." It amounts to 20 percent of world output. It has been attracting a flood of portfolio investments from Europe, seeking higher interest rates, wanting to participate in the American boom.

The hike felt around the world

In recent days and weeks, the euro and European stock markets have tracked the mood on Wall Street. So have markets in Japan and elsewhere. In the last two or three weeks, Wall Street gradually became convinced the Fed would crack down.

Indeed, in recent years, at least one or two Fed members would always speak up against the idea of raising rates. Now, sources familiar with the secretive body say, there are no "doves" left on the policymaking board. "The mood [among Fed officials] is that they have somehow found themselves behind the curve on inflation," says Mr. Malmgren.

"Don't fight the Fed," Bruce Steinberg, chief economist of Merrill Lynch, recently warned investors. He expects the Fed to hike the federal funds rate - the interest banks charge on overnight loans - by half a percentage point.

Home mortgages are already running around 8.6 percent, corporate bonds 8.9 percent, high-risk junk bonds 12.8 percent. Two recent developments, however, suggest to some economists that the Fed might not have to raise interest rates so high later this year to slow the economy.

On Friday, government statistics showed that wholesale prices experienced their sharpest drop in more than a year in April. The figures came a day after retail sales showed a slackening the same month - both indications that inflation, for now, remains in check. The stock market rose both days.

Beyond the immediate impact of the Fed's actions, economists worry about the effect of higher interest rates on the economy of the US and its trading partners. Though now convinced of the Fed's intention to slow the US economy, most economists expect gross domestic product in the US to rise about 4 percent this year - a still vigorous pace.

Impact of no more 'wealth effect'

One risk is what a prolonged drop in the stock market would mean, should it occur. David Wyss, chief economist of Standard & Poor's DRI, calculates that a 40 percent drop in stock prices from a March peak would shave 15 percent from household wealth. This would cut spending and increase saving enough to cause a recession. Stock prices have already dropped about 10 percent.

Democratic presidential candidate Al Gore and President Clinton are hoping the slowdown does not arrive before the election. By maintaining huge budget surpluses and buying up federal debt, thereby putting checks into the hands of former owners of Treasury security owners, they hope to push a slowdown beyond November.

A slowdown in the US would likely hurt Europe and much of the rest of the world. "The train cannot go faster than the engine [the US economy]," says Malmgren.

Higher interest rates here will be like a "vacuum cleaner," sucking in investments from abroad. A slower American economy will buy fewer imports from abroad.

Horne, in London, however, holds that the European economy is moving along sufficiently strong on domestic sales that it will survive a US slowdown nicely.

(c) Copyright 2000. The Christian Science Publishing Society

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