Fed Hints That Rate Hike Is Unlikely

By Nell Henderson
Washington Post Staff Writer
Thursday, March 22, 2007

The Federal Reserve left interest rates alone yesterday -- surprising nobody.

But the central bank did tweak the language of a statement it put out to suggest that it isn't likely to raise rates anytime soon, producing a giddy reaction on Wall Street, which had been pining for good news.

The Dow Jones industrial average gained 159.42 points, to close at 12,447.52, completing the blue chips' best three-day rally in more than two years. So far this year, the Dow is down slightly, while the broader Standard & Poor's 500-stock index and the Nasdaq composite yesterday moved into positive territory.

"The market just celebrated like the Fed had announced they were cutting rates," said Al Goldman, chief market strategist at A.G. Edwards & Sons. That was a welcome message to traders shaken by the Feb. 27 plunge in stock prices and worried since by turmoil in U.S. mortgage markets, he said. "Three weeks ago, the markets thought the world was coming to an end."

However, investors are wrong if they think the Fed is saying it's about to lower interest rates, Goldman and other analysts said. Rather, the statement the central bank put out suggests that it has opened the door to lowering rates if the economy deteriorates unexpectedly, giving itself the flexibility to respond as needed in a more uncertain environment.

"The odds have shifted toward an ease" in rates, said Ethan S. Harris, chief U.S. economist at Lehman Brothers. He attributed the change to concern about how the economy will be affected by rising mortgage delinquencies and home foreclosures, and the tightening of lending standards that has resulted. "It's something the Fed has to be nervous about."

"Easy lending standards artificially propped up the housing market last year. The tightening of standards this year is going to constrain activity," Harris said. "No one knows the scale of the shift. It is a big uncertainty in the outlook."

So far, the Fed sees the economy -- outside the struggling housing and automobile industries -- as generally healthy, with low unemployment and solid job growth in health care, education, finance, travel and other services.

Fed policymakers, in a statement released after their two-day meeting, held to their forecast that the economy will do fine in coming months, expanding at a moderate pace despite the housing slump.

And they emphasized that they remain more worried about inflation than about the economy's strength. The Fed forecasts inflation to drift lower but said its "predominant policy concern remains the risk that inflation will fail to moderate as expected."

But the Fed dropped language it had used previously to signal that it was more likely to raise interest rates to curb inflation than to cut them to boost growth.

Instead of referring to the possibility of further rate increases, the Fed statement said, "Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth."

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