Get ready for 9 percent interest rates

Despite rise in unemployment, analysts still expect Fed to raise rates several times.

There are finally some signs that the red-hot economy has stopped accelerating. But the slowing is unlikely to have any immediate influence on the economy's traffic cop, the Federal Reserve, which is still expected to hike interest rates in two weeks.

That rate hike, if it comes, is expected to be followed by yet more increases in interest rates in the months ahead. Some economists are predicting that by year's end interest rates, especially short-term rates, could be as much as 1 full percentage point higher than today.

This could ripple through to credit-card borrowers and people whose loans are linked to the prime interest rate that banks charge their best customers.

Most of the hikes are expected to take place early in the year, so the Federal Reserve does not become an issue in the final weeks of the presidential campaign.

Wall Street rarely likes rising short-term interest rates. Thus, last Friday stock markets were buoyed when the government reported the nation's unemployment rate in February rose from 4 percent to 4.1 percent. New job creation slumped as frigid weather forced contractors to delay construction projects. Hourly earnings, a sign of inflation, were up only modestly.

Investors reasoned that the unemployment report - watched closely by Fed Chairman Alan Greenspan - might indicate the central bank won't need to raise rates so much. This idea acted as a catalyst, driving the Dow Jones Industrial Average up 202 points on Friday, a nice rebound from its performance of recent weeks.

Despite the unemployment numbers, economists warn that there are still plenty of signs the economy is growing at a healthy rate. "The numbers are not a sign the economy is slowing: The numbers indicate it's not accelerating," says Lynn Reaser, chief economist for the Bank of America Asset Management Group in Jacksonville, Fla.

Most analysts believe the economy in the first quarter is growing at a 3.5 to 4 percent annual rate. They think the jump in the fourth quarter was due to spending on Y2K, which pumped up inventories.

But last week, Robert DiClemente, chief economist at Salomon Smith Barney, was surprised by the surge in auto sales. The last time auto sales reached this level was 15 years ago - when interest rates and gasoline prices were falling.

The strong consumer spending caused Mr. DiClemente to raise his estimate of first-quarter growth to 5 percent and the year's growth to 3.8 percent. "Car buyers are being buoyed by massive wealth gains in equities and housing," says DiClemente.

This is a theme echoed by Mr. Greenspan, who has said that the stock market gains need to get more in line with personal income. This would mean stock prices would grow no more than 6 percent a year, compared with the double-digit gains of the past few years. "This would be a major shift," says Ms. Reaser, who believes there is "some evidence" of a wealth effect.

Still, others question Greenspan's logic. "He is starting to reach for crazy theories to justify tightening," says Scott Grannis, who runs the $60 billion Western Asset Management in Pasadena, Calif. He sees signs that the markets don't believe Greenspan is correct.

"The dollar is making new highs every day, and it is inconceivable the dollar could be up so much at a time when he says we have a fundamental inflation problem," says Mr. Grannis, who maintains interest rates are already too high. He says the long-term bond market has yet to buy Greenspan's arguments and may have already peaked for the year. This would be good news for mortgage borrowers.

But others do see reasons for concern about inflation. Economist Sung Won Sohn of Wells Fargo Bank points to the effect of higher energy prices. Those prices, he says, will start to "seep" into the core rate of inflation, the number the Fed looks at. "That's one of the reasons why we should expect tighter monetary policy in the next six months," says Mr. Sohn, who expects the Fed to raise rates as many as three more times in the first half of the year.

Investors will get a better idea of how much higher oil costs are raising prices when the February consumer price index is reported on March 17. Initial expectations are for a jump of 0.4 percent - double the January rate.

But taking out food and energy, the volatile elements, leaves a rise of only 0.2 percent - the same as January. That report will be issued only days before the Fed meets to decide its next move.

(c) Copyright 2000. The Christian Science Publishing Society

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