Federal Reserve officials had no sense that the U.S. economy had hit a "soft patch" when they met in late June and decided to raise a key short-term interest rate for the first time in four years, according to newly released meeting minutes that show how policymakers' perceptions of the economy can lag the flow of events.
Member of the Federal Open Market Committee said at the June 29-30 meeting that the evidence "continued to portray an economy that was expanding briskly and was likely to continue to do so for some time," fueled by solid gains in employment, business investment and consumer spending.
Instead, economic growth had already slowed significantly, consumer spending had plunged and job creation was grinding nearly to a halt, according to data that became available only in the weeks following the meeting.
The contrast between the Fed's perceptions at the meeting and the figures released since show how quickly the economy can shift and how hard it is for policymakers to gauge the strength of an uneven economic recovery.
The snapshot of the Fed's optimism in June also shows confidence similar to that it continued to express this week, after its subsequent policymaking meeting. Central bank policymakers said in a statement issued Tuesday that the economy "appears poised to resume a stronger pace of expansion going forward."
"There is fallibility here" in making such a strong prediction, said David M. Jones, president of DMJ Advisors LLC, a Denver consultancy, who nonetheless praised the Fed for being so open about its thinking and expectations. "There is always a risk in trying to be too specific in a forecast. . . . But I would rather have the Fed give me what it has."
The minutes from each of the Fed sessions are not released until the following month's meeting, a long-standing policy.
The FOMC, the central bank's top policymaking group, raised its benchmark short-term interest rate at the June meeting for the first time in four years, to 1.25 percent from 1 percent. Committee members signaled then that they intended to keep raising the rate in small steps over time to keep inflation under control in an economy they believed was growing solidly.
Tuesday, at the July meeting, FOMC members blamed the recent "softness" on high energy prices, expressed a still-upbeat outlook, and raised the rate to 1.5 percent. The recent signs of weakness, they indicated, would pass.
The Fed's action and statement Tuesday show that central bank officials "haven't been very fazed by the data" since the June meeting, said William C. Dudley, chief economist at Goldman Sachs & Co. One reason, he said, is that many economic figures are not very reliable on a monthly basis because they are based on samples and are subject to seasonal adjustments and revisions.
More important, he said, Fed policymakers "have a tremendous amount of confidence that the economy is going to do fine. . . . and that rates are too low and have to be normalized" to avoid fueling inflation in the future.
In June, the FOMC "members focused particular attention on the outlook for inflation," the minutes said.
They noted higher oil prices, rising consumer prices, increased labor costs and a sense that businesses were beginning to expect inflation to keep moving upward. The lower dollar was also making many imports more expensive.
Some members argued that the recent inflation spurt was partly due to "what might well prove to be transitory factors," such as higher prices for energy and other imports. Some expected inflation to slow for reasons including still-high unemployment, which should hold down wage increases.
But other members worried that inflation tends to gather "considerable momentum" once unleashed.
Just a year earlier, in June 2003, the Fed lowered the benchmark federal funds rate -- the overnight rate charged between banks -- to 1 percent to help boost economic growth and prevent deflation, an economically debilitating fall in overall prices.
By this summer, Fed officials believed that the economy no longer needed so much stimulus and would suffer if cheap credit fueled a takeoff in inflation in the next year or so.
Fed Chairman Alan Greenspan acknowledged last month in congressional testimony that the economy had hit a "soft patch" but said he expected it to pass, citing signs that auto sales had already rebounded in July after falling in June.
Auto sales rose by a strong 2.4 percent last month, seasonally adjusted, after tumbling 3 percent in June, the Commerce Department reported yesterday. Analysts attributed the swing to auto dealers' unsuccessful efforts to trim rebates and other financial incentives in June and their subsequent decision to increase the incentives in July.
Overall retail sales rose 0.7 percent in July after falling 0.5 percent in June.
"Retail sales are slowly and gradually coming out of the soft patch," said Sung Won Sohn, chief economic officer of Wells Fargo Bank.
Energy prices are one important reason for the continuing weakness in consumer spending, but there are others, Sohn said. They include the waning effects of the recent tax cuts, slowing employment gains and concerns about terrorism.
Businesses, in turn, remain very cautious about hiring and expanding production because of such uncertainties, Sohn said.
"I was surprised by how [Fed officials] exuded confidence in the strength of the recovery" in their statement Tuesday, he said. "I don't think the rest of us are so sure."