Washington, March 18 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan is about to have one of his theories tested by President George W. Bush: that resolving the standoff with Iraq will aid the U.S. economy and give companies confidence to expand. Last night's ultimatum from Bush for Saddam Hussein to leave Iraq within 48 hours pushes the sides closer to war, and U.S. stock and bond markets are betting on a clear and quick U.S. victory. That's one reason why 62 of 72 economists in a Bloomberg News poll expect Greenspan and other Fed policy makers to hold its benchmark interest rate steady today, while possibly signaling a future reduction if needed. ``Greenspan said it is difficult to tell if it is war or something structural'' slowing the pace of economic growth, said Kevin Hassett, a scholar at the American Enterprise Institute and former senior economist at the Fed. ``We are about to find out.''
The Fed's benchmark overnight lending rate stands at 1.25 percent, the lowest since 1961. A reduction of a quarter-point to 1 percent would put the rate at the lowest since Dwight D. Eisenhower was president in July 1958. A sputter in the latest economic reports on jobs, retail and consumer confidence prompted some economists to lower growth forecasts for 2003 and predict the Fed will change its outlook statement today to say the economy risks weakening. That may signal a rate cut at or before the next Fed meeting on May 6. ``The trigger for an inter-meeting move would be if markets were to show bear-market behavior after the sand settles in Iraq,'' said Diane Swonk, chief economist at Bank One Corp. ``That would show structural problems with the economy rather than'' problems related to sentiment surrounding the war.
Market Performance
The Fed hasn't reduced rates between policy meetings since the week after the terror attacks on New York and Washington in September 2001. The Standard & Poor's 500 Stock Index and the Dow Jones Industrial Average both surged more than 3.5 percent yesterday, on investor expectations that a war with Iraq would be short and successful for the U.S. Still, both indexes are down for the year to date, after three straight years of decline. Additional declines would signal to the Fed that economic performance may worsen, economists said. The S&P 500 rose 3.7 percent on Jan. 17, 1991, the day after allied forces launched Operation Desert Storm, and gained 32 percent from pre-attack levels by the end of the year. The recession that began in July 1990 ended in March 1991, the month the Gulf conflict ended. ``You will see it first in the financial markets,'' said Joseph LaVorgna, senior economist at Deutsche Bank Securities Inc. ``If there is a war, and it is very successful, markets will reflect that and look for a better second half.''
Removing `Uncertainties'
Greenspan last month told the Senate that the ``most important stimulus is the removal of uncertainties'' about Iraq. That now may happen in a matter of days, after Bush told Hussein and his sons to leave Iraq within 48 hours or face war. ``Events in Iraq have reached the final days of decision,'' Bush said in a nationally televised speech from the White House Great Hall. ``Peaceful efforts to disarm Iraq have failed again and again because we are not dealing with peaceful men.'' Fed officials have generally expressed confidence in the underlying economy. San Francisco Fed President Robert Parry, a voting member of the Fed's policy committee, said March 4 that the outlook is ``by no means tipping in the direction of a `double- dip' recession.'' Since that time, the war threat has received some of the blame for a growing stack of disappointing economic reports. February retail sales fell 1.6 percent, the biggest drop since November 2001, and the economy lost 308,000 jobs in the same month. The University of Michigan's preliminary March consumer sentiment index fell to 75, the lowest since 1992. Consumer spending accounts for more than two-thirds of the economy, and February's drop in jobs and retail sales has economists marking down estimates of first-quarter growth.
Lowering Forecasts
The economy will probably expand 2.6 percent this year, based on the latest Blue Chip Economics Indicators survey. That's down from the 2.7 percent growth forecast a month ago and less than the 3.3 percent average annual rate for the past 50 years. Growth is slowing around the world, and other central banks have been cutting rates. The European Commission yesterday cut its economic growth forecast to about 1 percent, less than the 1.8 percent expected previously. This month the European Central Bank lowered its benchmark rate by a quarter point to 2.5 percent, the lowest in almost 3 1/2 years. In February the Bank of England cut its benchmark to 3.75 percent, the lowest since 1955, Winston Churchill's last year as prime minister. For the first time since World War II, the U.S. central bank faces two risks -- inflation as well as deflation. Prices of goods fell 0.7 percent last year, while service prices rose 3.1 percent, about in line with the gain in incomes. If the recent slump in demand causes accelerated price decreases, the Fed would most likely cut interest rates aggressively, economists said. Greenspan and Fed Governor Ben Bernanke have said they would opt for unconventional strategies, such as flooding the banking system with cash through purchases of long-term Treasury notes, if the federal funds rate fell toward zero and became a less effective tool to ward off a collapse in prices. //www.quote.bloomberg.com