Federal Reserve policymakers meeting yesterday left their target for overnight interest rates unchanged and ruled out the possibility of a rate increase before their next meeting in February because of concerns about the looming year 2000 date change.
But the members of the central bank's top policymaking group, the Federal Open Market Committee, said in a statement that they remain concerned that the economy is growing too fast for inflation to remain quiescent.
Increases in spending by American consumers and businesses continue to outstrip the economy's ability to produce the goods and services they want to buy, "even after taking account of the remarkable rise in productivity growth," the statement said. "Such trends could foster inflationary imbalances that would undermine the economy's exemplary performance."
Analysts had widely predicted the Fed would leave rates alone, but many thought the policymakers would also adopt a "bias" indicating the FOMC was leaning in the direction of raising rates. But the committee stuck with a neutral directive "in order to indicate that the focus of policy in the intermeeting period must be ensuring a smooth transition in the year 2000," the statement said.
"At its next meeting, the committee will assess available information on the likely balance of supply and demand, conditions in financial markets and the possible need for adjustment in the stance of policy to contain inflationary pressures," it said.
The Dow Jones industrial average staged a modest rally after the announcement, while the Nasdaq composite index posted its biggest point gain ever, rising 127 points, or 3.36 percent, largely because of the lack of a bias in the directive. Bond yields were little changed, remaining close to their highest level since the spring of 1997.
"Despite the decision by the FOMC to maintain a neutral directive today, the Fed's outlook for the economy in the months ahead is decidedly [not neutral]," said Dana Saporta of Stone & McCarthy, a financial markets research firm. "It would be a mistake to interpret today's announcement as a signal that policy is on hold for the foreseeable future."
Except for the potential problems that could be associated with the date change, the Fed would have adopted a biased directive or possibly have raised rates today, in Saporta's opinion.
Some other analysts think the Fed may postpone any action on rates beyond the beginning of February. That would give the policymakers more time to assess the impact on the economy from the three quarter-percentage-point increases in overnight rates they put in place over the past six months and to see if inflationary pressures are rising.
But just about everyone agrees that incoming economic data will be the key determining factor. "While we expect domestic demand to moderate in the first quarter, evidence of such moderation is lacking," said Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York. Any slowing is likely to be very limited, with growth dipping to about a 4 percent annual rate from about a 4.5 percent rate in the last three months of this year.
"In other words, the economy continues to grow faster than the Fed's notion of growth potential," Steinberg said, adding: "At this point another [half-percentage-point] tightening looks like the Fed's most likely course." The first quarter point of that should come at the Feb. 1-2 meeting, he said.
Between now and that meeting, the Fed is expected to announce changes in its policies concerning the nature of the "bias" statements it has been issuing after each of its policymaking sessions since last spring. Many of the officials have been dismayed at the reaction in financial markets when it has said the FOMC adopted a directive with a bias toward higher rates.
In short, the markets responded to the announcements essentially as if rates had been increased, which is not what the Fed wanted, since adoption of a biased directive does not necessarily indicate that rates will be raised.
At a meeting in August, Fed Chairman Alan Greenspan asked Vice Chairman Roger W. Ferguson Jr. to head a group of FOMC participants to seek ways to revamp the announcements. According to the minutes of the next meeting, in October, several officials urged Ferguson to come up with some answers as quickly as possible.
Some proposals for change were agreed to over lunch at a November FOMC meeting, and final details were largely ironed out in a telephone conference call a week or two later, with the intention that all the decisions be ratified at yesterday's session.
The first fruit of those discussions actually appeared yesterday. Under the FOMC's previous understanding, an announcement would only be made if the target for overnight rates was changed, or--if rates were left alone--if the presence or absence of a bias in the directive was changed.
At the November meeting, when rates were raised, a neutral directive was adopted. Since rates weren't changed yesterday and the directive remained a neutral one, under the old rules no announcement would have been made.
CAPTION: In August, Fed Chairman Alan Greenspan sought ways to revamp announcements.