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Fed holds rates steady, citing geopolitical risk

With the economy stumbling and possibility of war looming, the Federal Reserve Tuesday left short-term interest rates and monetary policy unchanged Tuesday.
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With the possibility of war looming over the economy and stock market, the Federal Reserve Tuesday left short-term interest rates unchanged at their lowest levels in more than 40 years. After a two-day meeting led by Fed Chairman Alan Greenspan, central bankers also left their monetary policy stance unchanged, saying the economic climate should improve gradually as the current “geopolitical risks” recede.

The benchmark federal funds rate, which sets the standard for a range of business and consumer loans, remains at 41-year low of 1.25 percent, where it has been since the Fed’s aggressive half-percentage point cut in November.

Some economists believe the Fed will lower the rate another quarter-point within the next several months in response to persistent economic weakness, and there had been speculation the Fed would shift its “bias” to reflect that possibility. But the Fed gave no hint of its intentions, electing to remain in so-called “neutral” policy position, saying risks of further economic weakness were balanced by the possibility of higher inflation.

With tens of thousands of U.S. troops mobilizing for a possible war in Iraq, and President Bush issuing harsh new condemnation of Saddam Hussein, central bankers probably concluded this was no time to signal a change in policy, analysts said.

“The Fed is not in any position right now to guide interest rate expectations up or down,” said Chris Wiegand, senior economist at Salomon Smith Barney. “They want to see more data and they want to see how Iraq goes. There is a widespread acknowledgement that Iraq is having a very major impact on business risk-taking and the financial markets.”

Maury Harris, chief U.S. economist at UBS Warburg, predicted the Fed will leave rates unchanged until August, when it will begin raising rates to what he called more normal levels.

“Although Fed officials have clearly not ruled out the possibility of more easing, they do not want to encourage expectations for more action,” he said in a note to clients.

In a statement, the Fed noted that higher oil prices and “other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses.” But Greenspan and other policy-makers on the Federal Open Market Committee believe the current low-rate environment and improving productivity will lead to an improving economic climate “over time” after the war risks pass.

Tony Crescenzi, chief bond market strategist for Miller Tabak & Co., called the statement a “validation” of the view that economic fundamentals continue to improve despite business hesitancy ahead of a possible war.

“It’s a very black-and-white statement. It’s just oil and geopolitics getting in the way of what (they) believe is a very good economic story,” he said. “The bears are lining up and saying even without Iraq you’ve got other issues, but one can’t deny the powerful psychological effect an end to this Iraq situation would bring.

Stock prices rose and bond prices fell after the Fed announced the committee’s unanimous decision. The Dow Jones industrial average, which had been down more than 100 points in early trading, was up 22 points or 0.3 percent at the close.

The economy has been struggling mightily to get back onto sure footing since tumbling into recession in early 2001. The economy grew unevenly last year, fading sharply in the final three months of the year. Economists estimate it grew at a rate of less than 1 percent in the fourth quarter, which would be its worst performance in more than a year. The government will report its initial estimates on fourth-quarter gross domestic product Thursday.

In his State of the Union address Tuesday, President Bush urged Congress to pass the tax-cut program he proposed earlier this month, which would lower government revenues by an estimated $674 billion over 10 years.

“Lower taxes and greater investment will help this economy expand,” Bush said in the speech. “More jobs mean more taxpayers and higher revenues to our government.”

Democrats have countered with smaller-scale plans that include more short-term stimulus and more aid to hard-pressed state and local governments.

Text of statement
Following is the full text of the Federal Open Market Committee’s statement issued on Wednesday following its two day meeting:

The Federal Open Market Committee decided today to keep its target for the federal funds rate unchanged at 1-1/4 percent.

Oil price premiums and other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses. However, the Committee believes that as those risks lift, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to an improving economic climate over time.

In these circumstances, the Committee believes that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are balanced with respect to the prospects for both goals for the foreseeable future.

Voting for the FOMC monetary policy action were Alan Greenspan, Chairman; William J. McDonough, Vice Chairman; Ben S. Bernanke, Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson, and Robert T. Parry.