Washington, March 18 (Bloomberg) -- Federal Reserve policy makers held interest rates at a 41-year low and surprised investors by saying the looming war with Iraq made it impossible to assess the outlook for the U.S. economy. The Federal Open Market Committee promised ``heightened surveillance'' of the economy, a statement some analysts said signaled a possible rate cut, perhaps even before its next meeting May 6. It was the first time the Fed declined to say whether the main risk to the economy is slow growth or inflation since it began publishing its view with rate decisions in 2000. ``The FOMC is turning over monetary policy to the military generals,'' said Chris Rupkey, senior financial economist at Bank of Tokyo-Mitsubishi Ltd. ``They want to wait and see what happens there, and then they can make a more intelligent decision.''
The central bankers held the rate at 1.25 percent, counting on the lowest borrowing costs in decades to propel the economy through a war with Iraq. Some forecasters have lowered growth projections for 2003 after the economy lost 308,000 jobs in February and consumer confidence this month sank to the lowest in more than a decade. ``We found out that they have no idea where the economy is heading,'' said Ethan Harris, chief economist at Lehman Brothers Inc. and a former research manager at the Federal Reserve Bank of New York. ``In the old days, they had three choices for their bias statement: easing, tightening, or neutral. They've added a fourth one: none of the above.'' The FOMC statement blamed a ``hesitant'' economic expansion mainly on oil price premiums and geopolitical events. ``The committee does not believe it can usefully characterize the current balance of risks with respect to the prospects'' for growth and price stability,'' the statement said.
Waiting on War
William Sullivan, a senior economist at Morgan Stanley in New York, said he was ``taken aback'' by the omission. ``It may be an honest approach but I believe it's unwarranted,'' he said. ``Investors are more reassured when the Fed acts decisively.'' Treasury securities extended losses after the Fed decision. The 3 7/8 percent 2013 note fell about 1/2 point, pushing up its yield 7 basis points to 3.89 percent, the highest in a month. The 1 1/2 percent 2005 note fell about 1/16 pushing its yield up 6 basis points to 1.69 percent, at 5 p.m. New York time. In their statement, Fed officials suggested that as the ``uncertainties'' surrounding the Iraq war lift, low interest rates and productivity increases will ``provide support to economic activity sufficient to engender an improving economic climate over time.''
`State of Paralysis'
Don Brock, chairman of Astec Industries Inc., a maker of road- building and construction equipment based in Chattanooga, Tennessee, said interest rates are low enough to boost growth. ``The uncertainty surrounding the war has got everyone in a state of paralysis,'' he said. ``We have customer after customer just waiting to spend money. They're not adding capital goods until we get a resolution.'' The decision to keep rates unchanged matched the forecast of 65 of 75 economists polled by Bloomberg News. ``The future of Fed action is largely dependent upon the outcome of the war,'' said Drew Matus, an economist at Lehman Brothers in New York.
Oil Prices Fall
President George W. Bush triggered a 48-hour global countdown to war Monday night by ordering Saddam Hussein to leave Iraq or face an attack. The ultimatum ends six months of diplomatic efforts aimed at forcing Iraq to disarm. For much of that time, Fed officials have held the view that the economy is passing through a transitory ``soft patch.'' Today's decision to hold rates steady suggests the policy makers still think the weakness seen in economic reports is related to war tensions and not a lasting deterioration in consumer or business spending and investment plans. Crude oil, for example, had its biggest decline in 16 months on speculation any war in Iraq will end quickly and with limited disruption to Middle East oil supplies. Crude oil for April delivery dropped $3.33, or 9.5 percent, to $31.60 a barrel as of 2:40 p.m. on the New York Mercantile Exchange, the biggest one-day drop for the contract nearest expiration since Nov. 15, 2001. Still, the change in the Fed's economic outlook shows central bankers are ready to change their minds on that view at any moment.
Fear of War
Factory-use rates are close to 18-year lows, and a University of Michigan survey showed that consumer confidence in mid-March slid to the lowest since 1992. The economy lost 308,000 jobs in February, and retail sales fell 1.6 percent that month, the biggest drop since November 2001. Consumer spending accounts for more than two-thirds of the economy, and the declines in sales and jobs have economists marking down estimates of first-quarter growth. 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. Economists said any further deterioration in consumption and employment data would most likely prompt an inter-meeting interest rate reduction by the Fed. ``It doesn't matter if fear of war is a temporary thing depressing spending,'' said Christopher Low, chief economist at FTN Financial. ``Consumers are keeping the recovery alive; and if the Fed is going to ease, it is going to be in response to weakening consumer spending.''
Discount Rate
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. The Fed's Board of Governors also left the discount rate on loans to banks from the Fed system unchanged at 2.25 percent. While few banks borrow directly from the Fed to meet their cash reserve requirements, the Fed loaned $45.6 billion through its discount window in the days following the Sept. 11 terrorist attacks. Last week, discount loans totaled just $45 million, a more typical amount. In recent years, the central bank has kept the discount rate within a half point of the overnight bank rate. On Jan. 9, the Fed changed the cost of discount window loans. So-called primary credit, the loan rate for healthy banks, is now set at 1 percentage point above the fed funds rate, and secondary credit, a rate for distressed banks, trades at 1.5 percentage points over the overnight rate. The policy meeting took place even though the Fed's Washington headquarters was closed today as police shut down Constitution Avenue during a standoff with a North Carolina man claiming to have explosives on the capital mall, which runs parallel to the street. //www.quote.bloomberg.com