Wary Fed Decides Against Interest Rate Hike for Now

WASHINGTON — The Federal Reserve Board decided Tuesday not to raise interest rates, despite fears by some members that increasing wage demands and a fast-growing economy may threaten to revive inflationary pressures.

The decision by the board’s policy-making Federal Open Market Committee was designed to provide time for analysts to determine whether the economy is slowing down on its own, as some recent economic statistics have suggested, or will require additional reining in.

The panel is expected to take up the interest-rate question again at its next meeting, scheduled for July 1 and 2. Analysts speculated that, if the economy has not slowed to a more sustainable pace by then, the central bank could well nudge interest rates up.

The Fed has come under unusually harsh criticism from Congress and big business since it raised short-term interest rates in March in what it termed “a preventive strike” against inflation.

Although the increase then was modest--only a quarter of a percentage point in the federal funds rate, which commercial banks charge each other on overnight loans--critics charged that the central bank was fighting an inflation threat that could not be seen.

Since then, signals from the economy have been decidedly mixed. While economic output surged at an unexpectedly robust 5.6% annual rate in the first three months this year, more recent statistics have shown that the economy is slowing markedly and that wage increases have remained in check.

“It was an awfully close call,” Robert G. Dederick, a Fed-watcher for the Northern Trust Co. of Chicago, said of the Open Market Committee’s decision Tuesday. “There were arguments on either side. You could have made a case either way.”

Tuesday’s action left the federal funds rate at 5.5%, the level to which it was raised in March. As is customary when it decides not to change existing rates, the panel did not issue any statement.

The Fed’s decision was greeted with relief both by business groups and financial markets. The Fed’s announcement sent stock markets soaring, with the Dow Jones industrial average gaining 74.58 points on the day and closing at 7,303.46.

The National Assn. of Manufacturers, which had vigorously opposed any further hike in interest rates, also hailed the Fed’s decision, contending that if the panel had decided to raise rates another quarter-point it would have hurt both growth and jobs.

“From living rooms to board-rooms, anyone concerned with economic growth and continued high employment can breathe easier,” Jerry Jasinowski, the organization’s president, said in a statement.

However, some economists suggested that the apparent slowing that some analysts now see will prove short-lived and that the economy will bounce back with a vengeance later this year, forcing the central bank to resume the tightening it began in March.

“Recent financial developments show that we’re on the cusp of a re-acceleration” in output, said Richard B. Berner, chief economist for the Mellon Bank in Pittsburgh. If that happens, he said, “I don’t think what the Fed has done today will be sufficient.”

Former Federal Reserve Board member Lyle E. Gramley agreed. Any slower growth during the current quarter “will be temporary and short-lived,” he said. Fast growth “could very well come roaring back” and force the Fed into action.

Analysts said that they expect the financial markets to remain volatile until the Fed’s July meeting. Investors have been worried that too large an interest-rate hike could push the economy into a slump, while failure by the Fed to act at all could send prices spiraling.

The Fed’s threat to start pushing interest rates higher began last December, when Chairman Alan Greenspan warned of early signs that labor costs might be accelerating and hinted that broader inflationary pressures might be about to intensify.

Greenspan has contended that the Fed must launch “preemptive strikes” against inflation because it takes many months for Fed policies to have an impact on the $7-trillion U.S. economy.

Analysts said that the rise of inflation during the late 1960s and 1970s was the major factor behind the economy’s ills during the 1970s and 1980s. Since the price spiral was finally tamed, the economy has been growing steadily again.

The Fed chairman pulled off a similar preemptive strike in 1994, raising interest rates briefly to ward off a suspected new round of inflation and since then has won plaudits for his management of the nation’s money and credit policies.

This time, however, the Fed has encountered harsh criticism, with both economists and politicians sharply divided over whether the central bank acted too early--firing its first salvo even before there was a target in sight.

Analysts had been split evenly over whether the Fed would tighten further at Tuesday’s session. Even some who believe that the economy is slowing on its own had speculated that the central bank might raise interest rates again just to show it is on top of the situation.

The Federal Open Market Committee also appeared to be divided on the question, at least according to recent speeches and statements by its members. Besides Greenspan, the 14-member panel includes Fed board members and presidents of the regional Federal Reserve Banks.

* INVESTOR DELIGHT: Wall Street cheers the Fed, at least for the moment. D1, D5

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

On the One Hand . . .

A Federal Reserve Board committee faced what many analysts consider “a close call” when it decided against raising interest rates Tuesday. Here are the arguments for and against raising interest rates:

IN FAVOR OF RAISING RATES

The economy has been overheating. Output surged at a robust 5.6% annual rate during the first quarter, a pace many analysts view as likely to lead to inflation.

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Wage pressures have been intensifying as many communities encounter labor shortages. If labor costs rise, companies will be forced to raise prices and inflation will accelerate.

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Inflation figures have shown some early signs of trouble. Consumer prices performed well. But the so-called “core” inflation rate--a more reliable measure--rose slightly.

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The Fed’s primary mission is to combat inflation early--long enough in advance to give its policies time to have an impact.

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AGAINST RAISING RATES

More recent economic indicators suggest the economy may be slowing down on its own. Retail sales have slipped and factory production is declining. Output is predicted to slow.

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Although there are some early signs of increasing wage hikes, labor costs have been kept in check, in part because the cost of providing fringe benefits has remained low.

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Despite the rise in the core rate, prices show no sign of renewed inflation. Producer prices--at the wholesale level--actually fell sharply last month.

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The Fed’s last rate-increase--on March 25--drew a raft of criticism. Adopting a wait-and-see strategy would hold off critics.

Source: Times Washington Bureau