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Fed Set to Lower Rates for Economic Push


Jun 25, 6:22 AM (ET)

By JEANNINE AVERSA

WASHINGTON (AP) - Federal Reserve policy-makers appeared ready to ratchet down a key short-term interest rate to its lowest level in 45 years in the hope it will energize consumer spending and business investment and help the economy snap out of a funk.

The quick, postwar economic boom that some economists had hoped for hasn't materialized. For the most part, businesses have been reluctant to ramp up capital spending and hiring, major factors holding back the economy's ability to return to full health.

Consumers, meanwhile, have been the main force keeping the economy afloat. Even they, however, have been more inclined to spend cautiously than to splurge amid the muddled economic climate and sluggish job market.

"It's hard to escape the feeling that the economy is just barely treading water," said Carl Tannenbaum, chief economist at LaSalle Bank. "There isn't a lot of energy out there."

The economy grew at a mediocre 1.9 percent annual rate in the first three months of 2003. Economists don't believe the economy fared much better in the current April-June quarter and may have done worse. Forecasts of the second-quarter economic growth rate range from 1 percent to more than 2 percent. In the last quarter of 2002, economic growth clocked in at a poky 1.4 percent annual rate.

Economic activity needs to crank up to a growth of around 3 percent or higher to get back into a more normal growth pattern and get companies to really start hiring, economists say.

Against this backdrop, economists widely expected Federal Reserve Chairman Alan Greenspan and his Federal Open Market Committee colleagues to slice the federal funds rates - now at 1.25 percent, the lowest since President Kennedy's first term - by either one-quarter of a percentage point or a bolder one-half point when they wrap up a two-day meeting Wednesday. An afternoon announcement was expected.

The funds rate is the Fed's main lever for influencing the economy. The last time the Fed cut the funds rate, the interest banks charge each other on overnight loans, was Nov. 6.

Reducing the funds rate to either 1 percent or 0.75 percent would push that rate down to a level since 1958.

"A rate reduction is all about taking out some insurance against the risks that the economy will be weaker than the Fed actually expects," said Bill Cheney, chief economist at John Hancock Financial Services.

Commercial banks probably would match any reduction in the funds rate with the same-sized cut to their prime lending rates, a benchmark for many consumer and small-business loans.

The prime rate, which generally moves in lockstep with the funds rate, currently stands at 4.25 percent, the lowest level since 1959. At either 4 percent or 3.75 percent, the prime would be at its lowest point since 1958.

A reduction to the funds rate also would be aimed at warding off the economically dangerous threat of deflation, a widespread decline in prices, something that could emerge from a stagnant economy, economists said.

Although Greenspan and his colleagues say the chance of deflation is remote, the central bank still must be alert because of deflation's potential to wreck the economy, they said. Fed policy-makers raised the specter of deflation at their last meeting on May 6 and have talked about it since then, raising expectations the Fed would cut rates at its June meeting.

"If deflation is really the concern, it is better to attack full out than piddle around," said Joel Naroff, president of Naroff Economic Advisors. "Thus don't be surprised if the rate cut is more aggressive than many think it will be."

The United States' last serious deflation occurred during the Great Depression. A bad case of deflation can lead not only to widespread price declines, from goods and services to real-estate and stocks, but also to job losses and pay cuts.

Economists are hopeful the economy will pick up more speed in the second half of this year, with some predicting a growth rate of around 4 percent. A new round of tax cuts signed into law by President Bush last month should help on that front, analysts say.

Even so, economists aren't expecting a quick turnaround in the job market. The nation's unemployment rate climbed to a nine-year high of 6.1 percent in May as businesses cut 17,000 jobs. Depending on the strength of economic growth in coming quarters, the jobless rate could hover in that range or move higher, economists say.

There have been a few encouraging signs for the economy's revival. Manufacturing activity, which has throttled back production and laid off workers, improved in May. New claims for jobless benefits, while still at high levels, have gone down for two weeks in a row, raising hopes that the pace of layoffs might be stabilizing.

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On the Net: Federal Reserve: http://www.federalreserve.gov

Copyright 2003 Associated Press.