Economists See Fed Poised to Push Down Interest Rates
Feb. 08, 1988
WASHINGTON (AP) _ The spotlight is on the Federal Reserve this week, with many economists predicting that it will risk rekindling inflation in an attempt to head off an election-year economic slide.
If the Fed does indeed move to boost the faltering U.S. economy by pushing down interest rates, the move will be welcomed by Republican presidential hopefuls as well as by borrowers.
Democrats hope to use sluggish economic growth as evidence of the failure of Republican policies while the Reagan administration is counting on lower interest rates supplied by the Fed to keep the economy humming through Election Day. The Fed is dominated by Reagan appointees.
The risk of that strategy is the possibility of unleashing higher inflation. Before the record collapse of the stock market last October, the Fed actually was tightening credit, concerned that declines in the value of the dollar would make U.S. inflation worse.
But the market crash caused the Fed to switch course and aggressively pump up the money supply in an effort to compensate for the $1 trillion loss of wealth caused by the decline in stock prices.
Many economists believe the central bank has already set in motion further easing moves because of the widespread belief the economy is about to slide into a period of very weak growth.
Top Fed policy-makers who sit on the Federal Open Market Committee will meet behind closed doors on Tuesday and Wednesday to assess economic conditions and set monetary policy for the year.
The results of those deliberations will be revealed when Fed Chairman Alan Greenspan testifies before Congress two weeks from now.
''The Fed is facing the prospect of very weak economic growth in the first quarter of this year. That provides ample reason for easing,'' said David Jones, an economist with Aubrey G. Lanston & Co., a government securities dealer.
The Fed's about-face since the stock crash is reflected in the course of mortgage rates.
Before Black Monday, fixed-rate mortgages had been climbing steadily, hitting a two-year high of 11.58 percent on Oct. 16.
But with the Fed switching to looser credit, mortgage rates began falling, dropping into single digits last week at 9.84 percent, the lowest level in 10 months.
Other interest rates have declined as well. Major U.S. banks trimmed their prime interest rates to 8.5 percent last week, the lowest this benchmark has been since mid-1986.
Economists say that an easier Fed money policy is not the only reason for the decline in rates. Financial markets also have bid rates down, in part because credit demand is expected to slow along with the economy in the first half of the year.
Economic growth, as measured by the gross national product, raced ahead at a robust annual rate of 4.2 percent from October through December, but the strength came almost exclusively from a buildup of business inventories while consumer spending actually was falling.
That can't go on forever. Manufacturers are likely to curb production and employment in coming months, economists believe. They are forecasting that GNP growth will dip dramatically in the first quarter of 1988, perhaps even registering a negative figure.
Some economists believe a recession, defined as at least two quarters of negative GNP growth, is inevitable this year, regardless of what the Fed does. But most are predicting that economic growth will rebound as the year progresses.
These economists are looking for interest rates to fall further, especially during the extremely slow growth early in the year.
Michael Evans, head of a Washington forecasting firm, said banks' prime rate could drop as low as 7 percent while fixed-rate mortgages could fall to 8.5 percent by early spring.
''Clearly the trend in rates is down, which is good news for homebuyers and for the economy in general, since a boost in the housing market should help offset some of the weakness in other sectors,'' said Cynthia Latta, an economist with Data Resources Inc., a Lexington, Mass., forecasting firm.
The Fed, in battling to keep the economy out of a recession, is receiving a break from other developments. A recent rally in the bond markets suggests that investors' fears about inflation are easing. In addition, the dollar has stabilized in recent weeks after several months of sharp decline.
These developments give the Fed more room to bring interest rates down, economists believe.
''Economic growth is far and above the issue concerning the Fed right now,'' said Allen Sinai, chief economist of the Boston Co., a subisidary of Shearson Lehman Hutton Inc. ''Inflation is not a problem and the dollar is stable.''