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Fed Holds Interest Rates Steady
Wording Change Scares Investors, but Economists See No Policy Shift
By Nell Henderson
Washington Post Staff Writer
Thursday, January 29, 2004; Page E01
Federal Reserve officials left a key short-term interest rate unchanged yesterday, but financial markets swooned after the central bank used slightly different language to signal it will continue to keep rates very low for a while.
Policymakers said in a statement after their meeting yesterday that they "can be patient" in holding rates low, dropping their previous commitment to do so "for a considerable period." Stocks tumbled after the language was released, as many investors apparently worried that the central bank might raise rates sooner than they expected.
The new phrase picked up words used repeatedly by Fed Chairman Alan Greenspan in recent months, leading several economists to conclude the central bank's message remains the same: Although the economy is clearly expanding, Fed policymakers will not raise rates until they see signs the recovery is on more solid footing -- specifically that businesses are using up more of their excess capacity, that the job market is brightening significantly and that inflation is not falling.
The Fed statement "doesn't mean they are going to hike rates any time soon," said Ethan S. Harris, chief U.S. economist with Lehman Brothers Inc., who thinks a Fed rate increase would come this summer at the earliest, and probably not until next year. "The Fed is still waiting for healing and is focused on getting growth going."
He added, however, that the change in phrasing "does look like they've taken another baby step" toward a rate increase.
The central bank's top policymaking group, the Federal Open Market Committee, first lowered its target for overnight rates to 1 percent, a 45-year low, in June. It has kept it there since then to help hold down borrowing costs on business and household loans, stimulating continued spending and economic growth.
Investors and economists disagree over how long Fed officials can maintain rates so low in an economy that is widely forecast to grow more than 4 percent next year. Some economists argue that the Fed is falling behind, and should have started raising rates already to avoid overheating the economy. Others worry that even a slight increase in the Fed's target will cause other interest rates to jump, possibly choking off the recovery and hopes for more meaningful job creation.
Fed policymakers first said after their August meeting that they could maintain low rates "for a considerable period," and had repeated that phrase after each meeting since then. But some officials have been uncomfortable with wording that could be taken too literally to imply a specific time frame, while others worried that markets would overreact when the language was eventually dropped to make way for rate increases.
Fed officials have worked to make clear that the length of the period will depend on how the recovery unfolds. On that basis, they have indicated, the period is likely to extend for several months, and perhaps more than a year. They believed they had prepared the markets for the day they would drop the phrase.
But stock prices fell yesterday as many investors worried that higher interest rates will slow economic growth. The Dow Jones industrial average fell 141.55 points, or 1.3 percent, while the broader Standard & Poor's 500-stock index dropped 15.57 points, or 1.4 percent.
"The Fed has blindsided the markets -- again, take an F for communications skills -- by dropping the 'considerable period' clause," wrote Ian Shepherdson, chief U.S. economist with High Frequency Economics Ltd. of Valhalla, N.Y., in a note to clients yesterday. "The Fed is slowly, and awkwardly, edging towards" a rate increase, he said.
Fed officials were so concerned in October about the markets' misunderstanding their intentions that they formed a working group to study ways to improve communication. On Tuesday, the group presented its findings to all 19 FOMC members, who had "productive discussions of a full range of communications issues" but made "no announcement of a specific change" in policy, a spokeswoman said yesterday.
The working group had finished its task, but the committee "maintains an ongoing interest in considering issues of effective communication with the public," the spokeswoman said.
James Glassman, senior economist at J.P. Morgan Securities Inc., said that yesterday was a good time to drop the "considerable period" language because the recent economic data have proved so disappointing that it should be clear the Fed is not going to raise rates soon.
Job creation remains feeble. Inflation by some measures is falling. And orders for durable goods, manufactured items expected to last several years, were flat last month after falling in November, the Commerce Department reported yesterday. After excluding volatile orders for transportation equipment, durable goods orders fell 0.7 percent, the second monthly decline in a row in the category.
Glassman said the economic news "is not taking one closer to a Fed tightening, it's pushing it farther out."
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