- The Washington Times - Monday, March 17, 2003

WASHINGTON, March 17 (UPI) — The Federal Reserve, despite a still fizzling economic recovery, is widely expected to leave short-term interest rates unchanged this week following its policy meeting.

The Fed, which meets Tuesday, is expected to leave the key federal funds rate, which influences borrowing costs throughout the economy, at 1.25 percent as the economy remains soft.

The Federal Open Market Committee is also expected to shift to an easing bias, which would leave the door open for the nation's top bank to trim rates later down the road.

Kristin Engelberger, vice president at Prudential Securities, said, "The weakness in the recent economic data has led to increased speculation for a Fed ease at this Tuesday's FOMC meeting, although a recent survey still shows the majority of dealers expecting the Fed to leave rates unchanged.

"The more widespread expectation is for the Fed to leave rates unchanged but shift the bias from neutral to easing, leaving the door open for a rate cut inter-meeting if necessary," Engelberger said.

Some economists suggest that if the nation goes to war, the Fed would have little control over the near-term fate of the economy.

Banc of America Securities' Chief Economist Mickey Levy said,

"When (Fed Chairman) Alan Greenspan delivered his semiannual testimony last month, he was sufficiently confident about the near-term economic outlook to devote half of the report to a discussion of longer run fiscal policy.

"While the economy had been growing at a below trend pace, the chairman felt that conditions were in place for the recovery to pick up. According to the committee, geopolitical risk continues to restrain the economy, but monetary policy was sufficiently accommodative and productivity growth robust that improvement likely lay ahead," Levy said.

"Since that time, economic releases have been mixed, but severe winter weather, war jitters and rising energy prices have hurt consumer spending and business demand for labor in the past month. We now expect economic growth to remain below 2 percent annualized this quarter, following weak growth in fourth quarter," Levy said.

"In light of these developments, the FOMC will likely re-adopt a balance of risks weighted toward economic weakness. However, partially in light of uncertainties surrounding the conflict that lies just ahead, we expect the FOMC to maintain its current 1.25 percent federal funds rate target," Levy added.

The FOMC consists of the seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year in order to determine the near-term direction of monetary policy. Changes in monetary policy are now announced immediately after FOMC meetings.

The Fed determines interest rate policy at its meetings. These occur roughly every six weeks and are the single most influential event for the markets. For weeks in advance, market participants speculate about the possibility of an interest rate change at these meetings. If the outcome is different from expectations, the impact on the markets can be dramatic and far-reaching.

The interest rate set by the Fed, the federal funds rate, serves as a benchmark for all other rates. A change in the fed funds rate, the lending rate banks charge each other for the use of overnight funds, translates directly through to all other interest rates from Treasury bonds to mortgage loans. It also changes the dynamics of competition for investor dollars: when bonds yield 10 percent, they will attract more money away from stocks then when they only yield 5 percent.

Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels.

This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.

The federal funds rate was cut to its current four-decade low of 1.25 percent back in November and held at that level at the central bank's last meeting in December and January.

The nation's top bank cut its target for short-term rates 11 times in 2001, a record for a calendar year, to fight the effects of a recession that likely began in March 2001 and was worsened by the Sept. 11 terror attacks.

The central bank cut rates at each of its eight scheduled meetings in 2001 and during three impromptu conference calls. Three of the reductions occurred after the Sept. 11, 2001, terrorist attacks in New York and Washington.

The Fed's decision on rates is expected at approximately 2:15 p.m.

EST Tuesday.

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