6 May 2003, 17:06  Fed May Leave Interest Rates Unchanged as Greenspan Waits for More Data

Washington, May 5 (Bloomberg) -- The slowest six months of U.S. economic growth since the last half of 2001 is unlikely to convince Federal Reserve policy makers that they should lower interest rates tomorrow, economists said. The economy grew at a 1.6 percent annual rate in the first three months of the year after a 1.4 percent pace in the fourth quarter. Consumer spending from January through March matched the weakest rate since the first quarter of 1993. Companies eliminated 48,000 jobs in April, bringing the three-month loss to 525,000. Unemployment, at 6 percent, matched the highest since August 1994.
It's too early to tell whether those figures represent reactions to the Iraq war or an underlying problem in the economy, Federal Reserve Chairman Alan Greenspan told members of Congress last week. Greenspan said he still expects growth to accelerate, without providing a specific forecast. ``My sense is that the chairman is of the mind that we are going to have the recovery going forward and doesn't want to act too preemptively if it isn't necessary,'' said Eric Engen, a resident scholar at the American Enterprise Institute and former senior Fed economist. ``He certainly didn't give any indication that he's willing to back too far off his optimistic forecast.'' In a Bloomberg survey, 69 of 71 economists said the central bankers will hold the benchmark overnight lending rate at its 41- year low of 1.25 percent in their policy meeting tomorrow. Lou Crandall, chief economist at Wrightson-ICAP LLC, and Avery Shenfeld, senior economist at CIBC World Markets Inc., are the only economists calling for a reduction in rate to 1 percent. ``The U.S. economy needs all the help it can get,'' said Shenfeld. ``Why would you be hesitant about cutting rates when inflation is plummeting and there hasn't been a job recovery at all?''
Poised to Expand
Greenspan told the House Financial Services Committee that while the data don't yet show it, the economy is poised expand at a ``noticeably better pace'' later in the year. ``The consensus of economic forecasters is that a material rebound in economic activity will develop in the second half of this year, and certainly a number of elements should be working in that direction,'' the chairman said. At the same time, Greenspan delivered two caveats. Business spending must revive to elevate the pace of growth, he said, and any further decline in prices that starts to erode business profitability would be ``an unwelcome development.'' Linking weak pricing power and weak business investment created a lot of chatter on Wall Street because it signaled a possible trigger for another interest rate cut. ``The Fed is now more concerned about disinflation than inflation,'' said Engen.
Weak Bias
How the chairman's comments might be reflected in the Fed's customary balance-of-risks statement isn't clear, analysts said. At its last meeting, the central bank abandoned its custom of providing an outlook because, members said, war clouded their forecasts. The economy's weak performance has some economists predicting the Fed will return to a so-called weak bias tomorrow and say slow growth is the greatest danger to the economy. Some analysts, however, suggest that the three-year-old statement has outlived its purpose and could be scrapped at Tuesday's meeting. ``You can't encapsulate the nuance of the meeting in one sentence,'' said Stephen Cecchetti, a professor of economics at Ohio State University and the former head of research at the New York Federal Reserve. Consumer prices, minus food and energy, rose at a 1.7 percent rate in the past 12 months through March, the smallest increase since 1966. Continued economic weakness could slow price increases even further, and test the Fed's desire to hold inflation at current levels.
A June Cut
Investors are pricing fed funds futures contracts to levels that imply the Fed will lower borrowing costs in June. The implied yield on the Fed funds futures for July delivery settled at 1.10 percent Friday. ``The Fed is discovering that there is a world of very low inflation that has new challenges that they have never thought about,'' said James Glassman, senior economist at J.P. Morgan Securities Inc. in New York. If the economy were growing at its full potential, which economists put at around 3.5 percent, falling rates of inflation would have the positive effect of boosting the amount of available cash consumers have to spend, leading to higher demand. Today, falling prices in the context of weak economic growth have the negative effect of sticking firms with excess plants, people, and equipment. ``The link between poor pricing power and capital spending comes through profits,'' said Carl Tannenbaum, chief economist at ABN Amro North America Inc. The pace of economic growth has ``a long way to go until companies are generating enough cash flow for CEOs to be forward-looking.''
`Animal Spirits'
While so far businesses are holding back, Fed officials say the rapid replacement cycles of computer and software should begin to add to spending, since the last time many companies upgraded was just prior to the millennium year change. They also expect companies to take advantage of tax legislation that doubles depreciation rates through 2004. Fed Governor Ben Bernanke in a speech last month said corporate profits should turn higher and blamed weak investment spending on pessimism whose sources could be the war, accounting scandals, or ``the depressive side of Keynesian animal spirits.'' And others said a Fed rate cut likely wouldn't help much. ``Is there enough profit potential to suggest that we can not only absorb the productive capacity we have and also now need more and better?'' said Kelly Matthews, economist at Wells Fargo Bank in Salt Lake City. ``The answer is right now in the middle of 2003 we don't need more ability to produce greater output.'' //www.bloomberg.com

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