NEW YORK, May 5 (UPI) -- The Federal Reserve, despite a still-fizzling economic recovery, is widely expected to leave short-term interest rates unchanged at a 42-year low Tuesday following the conclusion of its policy meeting.
The Fed is expected to leave the key federal funds rate, which influences borrowing costs throughout the economy, at 1.25 percent as the economy remains in an economic soft spot.
Mickey Levy, chief economist at Banc of America Securities, said though balance of risks statement will be a live issue, Fed Chairman Alan Greenspan (and likely the majority of the committee) remains cautiously optimistic about the economy's prospects.
In his testimony last week before the House Financial Services Committee, Greenspan noted concerns about business willingness to increase capital spending and the lingering sluggishness of labor markets.
"However, his (Greenspan's) update emphasized recent improvement in household attitudes and the rally in financial markets, including higher broad equity markets, narrowing corporate bond spreads and significantly lower energy prices," Levy said. "Combined with the positive fundamentals of solid productivity growth, low interest rates and stimulative fiscal policies, Greenspan expects a strengthening economic recovery."
Levy noted that Greenspan emphasized the FOMC's willingness to employ more expansionary monetary policy if it is needed, and the Fed chairman went as far as to say for the first time that "with price inflation already at a low level, substantial further disinflation would be an unwelcome development ..."
But, Levy said, the FOMC was likely to bide its time, watching for a pickup in consumer and business spending.
"We believe that continued weak production-side data reflect the inevitable adjustment to the spending slowdown of fourth quarter of 2002 and the first quarter of 2003," he said. "With the severe winter behind us, confidence lifted by the outcome of the Iraq conflict and the accompanying reduction in uncertainty, energy costs declining substantially, and a significant proportion of household adjustment to lower levels of net worth now completed, a gradual pickup in consumer and business spending growth is in prospect."
Levy also said economic growth in the second half of 2003 should be at least 3 percent annualized, but significant reductions in unemployment were unlikely until 2004.
The FOMC consists of the seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. It meets eight times a year to determine the near-term direction of monetary policy. Changes in monetary policy are announced immediately after FOMC meetings.
The Fed determines interest-rate policy at its meetings, which occur roughly every six weeks and are the single-most influential event for the markets. For weeks in advance, market participants speculate about the possibility of an interest rate change. If the outcome is different from expectations, the impact on the markets can be dramatic and far-reaching.
The interest rate set by the Fed, the federal funds rate, serves as a benchmark for all other rates. A change in the fed funds rate, the lending rate banks charge each other for the use of overnight funds, translates directly through to all other interest rates from Treasury bonds to mortgage loans. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity.
In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels.
This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the stock market, while lower interest rates are bullish.
The federal funds rate was cut to its current four-decade low of 1.25 percent back in November and held at that level at the central bank's last meetings in December, January and March.
The nation's top bank cut its target for short-term rates 11 times in 2001, a record for a calendar year, to fight the effects of a recession that likely began in March 2001 and was worsened by the Sept. 11, 2001, attacks. The central bank cut rates at each of its eight scheduled meetings in 2001 and during three impromptu conference calls. Three of the reductions occurred after the 2001 terrorist attacks on New York and Washington.
The Fed's decision on rates is expected at approximately 2:15 p.m. EDT Tuesday.