Speculation Growing That Fed May Lower Interest Rates

The runaway dollar paused for breath Tuesday as the Bush Administration reaffirmed its pledge to keep exchange rates steady and speculation emerged that the Federal Reserve might soon start to lower interest rates.

A day after the White House expressed concern that the surging dollar could damage U.S. trade prospects, Secretary of State James A. Baker III said Washington was committed to working closely with its allies on economic policy and exchange rates.

“I think it’s important that the major industrial democracies of the world continue to work to coordinate their economic policies,” Baker said. “It’s really the coordination of those underlying economic policies that’s going to make a difference in terms of exchange rate stability.”

Bush’s chief economic adviser, Michael J. Boskin, also sought to end speculation that the Administration was willing to tolerate a stronger dollar, which reached a 29-month high against the West German mark this week.

“The Administration has not changed its policy,” Boskin told reporters.

Although a firmer dollar dampens inflationary pressure by making imports cheaper, Fed and Treasury officials are worried that progress made in the past two years toward closing the U.S. trade gap will grind to a halt if the dollar continues to “misbehave,” as one senior central banker put it.

Top Administration officials, including the President and Treasury Secretary Nicholas F. Brady, have been cajoling Fed Chairman Alan Greenspan to lower interest rates virtually since the day the President took office Jan. 20.

But Greenspan resisted and continued to push rates higher until February to curb inflation. An Administration official said the seven-member Fed board of governors is now more willing to think about easing its tight grip on credit.

However, the Fed’s action in draining cash from the banking system this week and recent comments by Fed officials suggest that any relaxation in the period ahead will be cautious.

“Inflation isn’t dead,” Fed governor H. Robert Heller said Tuesday. “Inflation is still a key factor to be considered in monetary policy-making. You don’t want to declare victory all too soon,” he told the National Economists Club.

Doubt About Interest Rates

“You’ve got to proceed in a prudent fashion,” Heller said when asked whether it was time to ease monetary policy.

Fellow governor Wayne Angell, in an interview with the Washington Post published Friday, appeared to rule out any easing of interest rates to rein in the dollar.

Asked whether the United States and other leading industrial countries should launch an aggressive policy to bring down the dollar, Angell said, “I can’t imagine anything that would be more fraught with potential disaster for the world’s financial system.”

David Hale, chief economist at Kemper Financial Services in Chicago, said he doubted that the Fed would loosen its grip on credit, especially after Tuesday’s surprisingly large 2.9% rise in durable goods orders for April.

He thinks that growth has slowed only modestly from last year’s 3.9% pace, perhaps to the 2.5% to 3.0% range.

“I can’t believe in light of the durable goods orders that they’ll want to ease unless the dollar skyrockets,” Hale said.

By contrast, Stephen Slifer of Shearson Lehman Hutton in New York believes that the Fed has already begun to let interest rates drift lower to prevent the increasingly evident slowdown in consumer buying from killing the 6 1/2-year expansion.

“There has to be a real fear on their part of overdoing it and dumping us into a recession,” Slifer said.

He said the federal funds rate, the overnight lending rate among banks that influences the cost of money throughout the economy, is likely to edge down by about five basis points, or hundredths of a percent, a week for the next month.

“It’ll be a very slow, gradual move,” Slifer said.

Fed funds averaged 9.75% last week, down from 9.86% the week before and the first time in several months that it had dropped below 9.80%.