Fed leaves key interest rate unchanged for now

By JEANNINE AVERSA

Associated Press

WASHINGTON – The Federal Reserve, faced with a rapidly slowing economy, decided today to leave a key interest rate unchanged and signaled that it stood ready to cut interest rates if necessary to keep the country out of a recession.

The central bank’s decision came after a closed-door meeting of the Federal Open Market Committee – the officials, including Fed Chairman Alan Greenspan, who set interest rate policy.

On Wall Street, stocks rose after the Fed’s announcement with the Dow Jones industrial average up 111 points in afternoon trading.

Given the decision to leave rates unchanged, a key short-term interest rate controlled by the Fed, called the federal funds rate, will stay at a nine-year high of 6.5 percent. The funds rate is the interest banks charge each other on overnight loans.

For the first time in two years, the Fed changed its policy directive, intended to signal future rate moves, to state that it no longer sees inflation as the primary threat facing the economy.

Instead, the Fed said that economic weakness is now the greatest threat facing the United States.

“While some inflation risks persist, they are diminished by the more moderate pace of economic activity,” the Fed said in its statement.

The change in the policy statement went even further than many economists had predicted.

They had felt that the Fed would switch from a directive weighted toward inflation risks to a neutral stance, which would signal that it views the risks equally balanced between inflation and recession.

By switching to a directive weighted toward recession risks, the Fed provided support for those analysts who are looking for rate cuts to begin as soon as the Fed’s next meeting on Jan. 30-31.

The last time the Fed cut rates was in 1998 in response to the global economic slowdown triggered by Asia’s financial crisis.

Bruce Steinberg, chief economist for Merrill Lynch, said of the central bank’s policy change: “Basically, the Fed has acknowleged that the U.S. economy hit an air pocket in December.”

Among the threats facing the economy, the Fed cited slowing consumer demand and weaker corporate profits from rising energy costs. It also noted the fall in consumer confidence.

The Fed statement also noted “reports of substantial shortfalls in sales and earnings and stress in some segments of the financial markets.” It said all of these developments indicated that the economy, which slowed dramatically during the summer, “may be slowing further.”

Beginning in June 1999 through May of this year, the Fed raised interest rates by 1.75 percentage points in six steps to slow the red-hot economy to a more moderate pace of growth.

Those Fed rate increases were accompanied by similar increases in commercial banks’ prime lending rate, the benchmark for millions of consumer and business loans, pushing it to a nine-year high of 9.5 percent.

In the third quarter, the economy slowed significantly to an annual growth rate of 2.4 percent, the weakest pace in four years. That compared with a 5.6 percent rate in the second quarter.

Greenspan telegraphed a major shift in Fed thinking in a speech two weeks ago when he said he believed the economy had slowed “appreciably.”

President-elect Bush, after meeting Monday with Greenspan, said Congress should pass his massive tax cut “as an insurance policy” against a potential economic downturn.

But the $1.3 trillion reduction in taxes over 10 years, which Bush made the centerpiece of his economic program, could face a major hurdle in Greenspan.

The Fed chief has said repeatedly he would like to see the government’s budget surpluses used to pay down the national debt, not provide tax relief or boost spending on government programs. But Greenspan has always been quick to add that if this can’t be done politically, he would prefer tax cuts to spending increases, which he warns could bring back the days of budget deficits.

Greenspan recently said policy makers must be alert to unexpected shocks that could derail the nearly 10-year-old economic expansion, the longest in U.S. history.

Talking to reporters Monday, Bush made a point of praising Greenspan for his agile handling of the world’s largest economy. Greenspan, a Republican, was first appointed Fed chairman by Ronald Reagan in 1987.

“We had a very strong discussion about my confidence in his abilities,” Bush said. He made no mention of his father’s belief that he lost the White House in 1992 because Greenspan was slow to cut interest rates.