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msnbc.com

The Commerce Department is on the verge of reporting the best quarterly economic growth in nearly four years, but don’t look for Federal Reserve officials to break out the Champagne just yet.

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Fed Chairman Alan Greenspan and his central bank colleagues meet Tuesday to discuss the state of the economy and undoubtedly will take note of the surge in growth over the past several months, led largely by consumer spending. But in their closely watched statement, to be issued shortly after 2:15 p.m. ET, they also need to caution that the outlook includes enough risks to justify leaving interest rates unchanged at their current historically low levels for the foreseeable future, analysts said.

Professional forecasters are nearly unanimous in the view that the Fed will leave its benchmark federal funds rate unchanged at a 45-year low of 1 percent — not only this week but well into 2004. Even though the economy is likely to show growth of 6 percent or more for the third quarter, the best rate since late 1999, the nation’s employers have shed 2.6 million jobs over the past two years, adding jobs in September for only the first time in eight months.

Without stronger job growth, the latest economic rebound could sputter out next year, a prospect that worries Fed policy-makers as well as Bush administration officials. And with inflation already well below the Fed’s presumed target for price stability, the central bank can afford to keep rates low until the labor market shows clear signs of recovery, ensuring a sustainable cycle of economic growth, economists say.

“I think what the Fed has been telling us is that in the absence of inflation they’re looking at labor market growth,” said Drew Matus, an economist at Lehman Bros. “One quarter of very high GDP growth makes headlines. It doesn’t get the labor market growing.”

Recent figures on employment have been modestly encouraging, with weekly claims for new unemployment benefits falling below the key 400,000 level that signifies stability in the jobless rate. Employers added an estimated 57,000 jobs in September — far below the 150,000 needed to absorb new workers entering the labor force, but a welcome turnaround after the economy shed 551,000 jobs in the preceding seven months.

“We’re still in the very early stages of faster growth,” said Bob Gay, global strategist at Commerzbank Securities. “It’s way too early for them to be worried about inflation, in part because inflation is a lagging variable.”

In fact the biggest worry expressed by Fed officials so far this year has been the possibility of what they have called an “unwelcome fall” in inflation that could lead to a destabilizing spiral of falling prices, or deflation. Given the likelihood of growth at or above 3.5 percent in the next several quarters, along with the best corporate profit growth in years, deflation has become an even more remote possibility, Gay said.

He expects the Fed to begin shifting its policy statement early next year and boost the federal funds rate to 1.5 percent by mid-2004, taking back some of the “insurance” rate cuts implemented over the past year in response to stubbornly slow economic growth.

Forecasters widely expect the economy to slow substantially in the current quarter and early next year as the effects of this year’s federal tax cut wears off, including the one-time stimulus of millions of tax rebate checks mailed to taxpaying parents in July and August.

Fed officials, however, are likely to steer clear of any talk of waning fiscal stimulus, partly because they do not want to be seen as encouraging an election-year tax cut at a time of rising deficits, Gay said.

The economy also has continued to benefit from historically low mortgage rates that reached their own 45-year low in June, fueling another wave of mortgage refinancing and boosting home sales. Sales of existing homes rose to a record pace in September, and sales of new homes exceeded expectations.

“Housing is at the mountaintop,” said Mark Zandi, chief economist at forecasting firm Economy.com. “We’ll still see some very strong numbers, just not the boom numbers we’ve had.”

Ironically, he said, housing sales will decline quickly if employment surges because the final piece of the growth puzzle will be in place, triggering higher mortgage rates. It was just this counterintuitive notion that Treasury Secretary John Snow recently highlighted, much to the disappointment of many Wall Street traders.

Even though Snow’s interpretation was accurate, his comments were harshly criticized because he appeared to be talking up interest rates well in advance of the job growth he predicted.

The Fed, on the other hand, will likely retreat to the safety of its dense and sometimes inscrutable Fedspeak to describe how the risks of deflation remains a bigger concern than any prospects of a slowdown in growth. With its long rate-cutting campaign almost certainly over, the central bank will want to do all it can to postpone an increase in longer-term interest rates, which are set on the open market.

“All they have to say is that there is a lot of excess capacity in the economy and inflation is very low, so they have a lot of room to keep interest rates low for a long time,” said Zandi. “They don’t want to upset any financial markets.”

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