INTEREST RATE AT 45-YEAR LOW

Fed holds key rate at 1 percent


Published: Thursday, January 29, 2004 at 6:01 a.m.
Last Modified: Thursday, January 29, 2004 at 12:17 a.m.
WASHINGTON - The Federal Reserve left a key short-term interest rate at a 45-year low on Wednesday but dropped a promise it had been making since August to keep rates low "for a considerable period."
The wording change was enough to jolt financial markets, sending stock prices plunging, even though private economists said they believed the Fed still planned on keeping rates unchanged for most of this year.
The Dow Jones industrial average, which had been in positive territory before the Fed's afternoon announcement, lost more than 100 points in late afternoon trading.
Bond prices dropped as well, sending interest rates set by the market sharply higher.
Short-term rates tied to Fed actions did not move at all because the Fed left its target for the federal funds rate, the interest that banks charge on overnight loans, unchanged at 1 percent, where it has been since last June. That means commercial banks' prime rate, the benchmark rate for millions of consumer and business loans, remains unchanged at 4 percent, the lowest rate since 1959.
The adverse market reaction occurred because the Fed dropped the phrase it had included in its last four policy statements - that it believed it low inflation and slack utilization of resources gave it the leeway to keep rates low "for a considerable period." Instead, the central bank, still citing the low inflation and slack resource utilization, said it believed "it can be patient" in deciding to raise interest rates.
While the wording change was subtle, Wall Street worried that by dropping the phrase "for a considerable period," the central bank is getting closer to beginning a series of rate hikes to make sure the rebounding economy does not trigger inflation.
Still, private economists said the statement as a whole does not indicate the central bank is edging closer to a rate hike.
"The Fed is getting the market ready for tighter monetary policy eventually, but they are not going to raise interest rates any time soon," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.
Complicating the issue this year is the presidential election. The central bank usually tries to avoid changing rates too close to the November vote out of concern that it could be seen as trying to favor one party over the other.
For that reason, many economists said they still believe the central bank will stay on hold until after voters go to the polls in November.
"We have a slight change in wording, but I don't think there will be any change in policy until after the election," said David Jones, head of DMJ Advisors, an economic consulting firm. "The Fed is not going to act anytime soon to hike interest rates with inflation low and the unemployment rate still high."
The Fed last raised rates in June 2000, when it hiked the federal funds rate by a half-point to 6.5 percent, the last in a series of six rate increases the central bank had begun in June 1999.
Those rate hikes did slow economic growth, but they also contributed to a bursting of the stock market bubble in early 2000. The fallout pushed the country into a recession in March 2001, ending a 10-year economic expansion, the longest in U.S. history.
Seeking to combat the growing economic weakness, the Fed started in January 2001 to cut interest rates in a series of moves that picked up momentum after the Sept. 11, 2001, terrorist attacks, making 2002 the most aggressive period of rate cuts since Federal Reserve Chairman Alan Greenspan took the top Fed job in 1987.
Most of the rate cuts occurred in 2001, although 2002 saw a half-point cut and a quarter-point cut. That reduction last June pushed the funds rate down to 1 percent, the lowest it has been since Dwight Eisenhower was president.
The Fed last June was concerned about the remote possibility that the country's long period of economic weakness could trigger a destabilizing bout of falling prices, or deflation, something last seen in the United States during the Great Depression.
In its statement Wednesday, the central bank said the upside and downside risks to achieving acceptable economic growth were roughly in balance.
It made no change in this so-called "balance of risk" assessment, although the central bank has appointed a working group of officials who are studying ways to improve the wording of this section of the Fed's statement. The assessment is designed to signal to markets possible future rate moves, but last year it generated a fair amount of confusion after the central bank split the balance of risks into an economic growth assessment and an assessment of whether inflation or deflation posed the greater threat.
Analysts said the fact that there was no change in the "balance of risks" portion of the statement probably indicated that Fed policy-makers remain split on what improvements need to be made.

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