Fed Reveals Concern Over Housing Slump

Heightened concern about a harsher-than-expected housing slump was a key factor in the Federal Reserve's decision to hold interest rates steady at its policymaking meeting last month.

Minutes of the Fed's deliberations, released yesterday, show that policymakers expressed worry over the real estate bust while they repeated that their aim was to make sure inflation continues to recede.

The bleak assessment of the housing market unnerved investors who were betting that the sector's problems would not spill over into other sectors of the economy. Release of the minutes sapped strength from the market on a day that had seen triple-digit gains and a new trading high for the Dow Jones industrials. The Dow ended the day up 11.37, or 0.09 percent, at 12,474.52.

"The concern is that the Fed was seeing something at their last meeting that suggested potentially more pronounced weakness than we had all been anticipating in the economy," said Drew Matus, senior economist at Lehman Brothers.

The Fed left its benchmark short-term interest rate unchanged at 5.25 percent last month, its fourth straight meeting without changing the rate. But the Fed also left the door open to a rate increase, if needed, to thwart inflation.

However, one Fed member, who was not identified in the minutes, said the central bank should have held out the possibility of a rate cut. That member thought the Fed's statement last month "should emphasize that policy could be adjusted in either direction, depending on the evolution of the outlook for inflation and economic growth."

The Fed's statement after the meeting, however, did not speculate about a rate cut. Rather, policymakers stuck to previous language about the possibility of a rate increase, something most economists think is not likely to happen.

Many economists say the Fed will hold rates steady at its next meeting, Jan. 30-31, and further into the new year. The next rate move, many analysts and investors say, will probably be a rate cut later in 2007.

At their December meeting, Fed policymakers said economic growth had slowed in 2006, partly reflecting a "substantial cooling" of the housing market. That description went beyond the Fed's previous assessment in late October and suggested that a sharper slump in housing could be taking place.

The policymakers suggested that the economy was in for sluggish growth because of the housing slump and that people needed to stay alert for signs that weakness in housing could infect the rest of the economy.

The minutes noted that growth in business investment had slowed and manufacturing had cooled, in part reflecting the struggling automotive industry. Consumer spending -- the lifeblood of the economy -- seemed to be holding up fairly well, yet there were risks that could change.

"Considerable uncertainty regarding the ultimate extent of the housing market correction meant that spillovers to consumption could become more evident, especially if house prices were to decline significantly," the minutes said.

Meanwhile, policymakers also made clear that they wanted to see "core" inflation, which excludes food and energy prices, move lower. They stuck to their forecast that this was likely to occur in the months ahead.

That said, "all members agreed that the risk that inflation would fail to moderate as desired remained the predominant concern," according to the minutes.