Rates Will Stay Put, Economists Predict
With a patchy U.S. economic recovery underway and few signs that inflation poses an imminent threat, most economists say they expect the Federal Reserve to wait until at least the latter half of this year before raising interest rates.
Analysts are united in one opinion--none of them expects the policymaking Federal Open Market Committee to act when it meets Tuesday, leaving the bellwether federal funds rate, which influences borrowing costs throughout the economy, at a four-decade low. And many see policymakers indulging the fledgling economic recovery for yet a few more months.
“They have the luxury of time,” said Richard Berner, chief U.S. economist at Morgan Stanley in New York.
The central bank staged one of its most aggressive campaigns in history last year, cutting interest rates 11 times, for a total of 4.75 percentage points, to help prop up the ailing U.S. economy, hammered anew after the Sept. 11 attacks.
But the economy, fueled with the added liquidity from a federal funds rate of 1.75% and a stimulus package of tax cuts and other measures, has headed for better days, adding to expectations of rate increases in the months ahead.
The question is how many months. Softer data in recent weeks, including the April employment report, which showed a jump in the jobless rate to a level unseen since 1994, have many economists believing that rate rises are more probable in August or beyond.
A Reuters survey of 21 primary dealers, firms that deal directly with the Fed, found that no one expects the central bank to raise the federal funds rate Tuesday. Just one firm still sees a move at the Fed’s next meeting at the end of June, versus 10 in a similar poll taken two weeks ago. Of the 21, 16 expect the first rate increase at the Aug. 13 meeting.
However, although there are some economists quietly expressing the view that the central bank could wait out the entire year without shifting interest rates, most see the Fed beginning to tighten this year to, among other things, ward off future risks of inflation.
“There are a lot of things out there that say inflation is well under control now. The fact of the matter is I think that this is as good as it gets on inflation,” said Berner, who sees August as the most likely time for a rate rise.
“The Fed in August is likely to begin a process of recalibrating monetary policy to neutral, which could take up to a year,” he added.
Even though the economy is well into recovery--logging a swift 5.8% rate of growth in the first quarter--labor market weakness is likely to be the key factor that will keep the Fed cautious on hiking interest rates, economists say.
“The conditions in the labor market are still not strong enough to really tell us that the complete deterioration in the labor market is behind us,” said Anthony Chan, chief economist at Banc One Investment Advisers in Columbus, Ohio.
And even if things turn around in the near future on the labor front, analysts say the Fed isn’t likely to raise rates until there have been several months of steady job growth.
“The Fed isn’t just going to start raising rates on the first sign of someone finding a job,” said James Glassman, senior economist at J.P. Morgan Chase in New York. “But at some point companies have to start hiring, and my guess is by summer we’re going to see some better news.”
On Friday, the Labor Department reported that the unemployment rate surged in April to 6%, the highest since a matching level in August 1994, from 5.7% the month before. The steep jump in the unemployment rate overshadowed the fact that U.S. firms added jobs to their payrolls for the first time in nine months during April--just not enough jobs to absorb a big jump in the work force.
Nonfarm payrolls rose 43,000 in April after a revised loss of 21,000 in March. The March payrolls number suffered a sharp negative revision from a gain of 58,000.
Complicating the picture for April was the fact that 565,000 more people joined the work force, swelling it to a record-high 142.57 million Americans who either held jobs or were looking for them last month.
Despite the complexities of the report, the numbers taken as a whole heightened concerns about the recovery and bolstered the conviction that rate rises were still some months away.
“The Fed should do nothing,” said Robert Macintosh, an economist with Eaton Vance Management Inc. in Boston. “The economy right now is just barely moving forward, and that’s not an environment for the Fed to raise rates. I don’t expect rates to rise this year.”
And though most economists believe the Fed’s first rate increase will come no sooner than August, some question how fast the rises will follow thereafter.
The central bank was quick to ease monetary policy last year as the economy fell into recession, but the pace of the recovery now underway is likely to dictate how frequently and by how much it will increase rates.
“This is going to be a gradual economic recovery. If it is a gradual recovery then there is no reason for them to move in like gangbusters,” Chan said.
But some economists worry that the Fed, if faced much later in the year with the prospect of inflation, may have to act with bigger interest rate rises.
“They will probably be playing catch-up,” said Paul Kasriel, chief economist at Northern Trust Co. in Chicago.
“We’ve seen the dollar weaken and we’ve seen industrial commodity prices, with or without energy prices, move up. The market is beginning to anticipate higher inflation and yet [Fed Chairman Alan] Greenspan wants to be reactive,” Kasriel added.
