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Thursday, January 29, 2004 - Page updated at 12:00 A.M.

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Markets
Selling erupts when Fed omits promise to keep rates low

By Martin Crutsinger
The Associated Press

JOHN ZICH / BLOOMBERG NEWS
The Chicago Mercantile Exchange’s Eurordollars futures pit reacts to yesterday’s news that Federal Reserve policy-makers dropped a commitment to hold interest rates low “for a considerable period.”
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WASHINGTON — The Federal Reserve left a key short-term interest rate at a 45-year low yesterday but dropped a promise it had been making since August to keep rates low "for a considerable period."

The wording change was enough to jolt financial markets, sending stock prices plunging, even though private economists said they believed the Fed still planned to keep rates unchanged for most of this year.

The Dow Jones industrial average, in positive territory before the Fed's afternoon announcement, lost more than 140 points in late-afternoon trading.

The adverse market reaction occurred because the Fed dropped the phrase it had included in its past four policy statements — that it believed low inflation and slack utilization of resources gave it the leeway to keep rates low "for a considerable period."

Instead, the central bank, though still citing those economic two factors, said it believed "it can be patient" in deciding to raise interest rates.

While the wording change was subtle, Wall Street worried that by dropping "for a considerable period," the Fed is getting closer to starting to raise rates to make sure the rebounding economy does not trigger inflation.

Still, private economists said the statement as a whole does not indicate the central bank is edging closer to a rate increase.

"The Fed is getting the market ready for tighter monetary policy eventually, but they are not going to raise interest rates any time soon," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

Complicating the issue is the presidential election. The central bank usually tries to avoid changing rates too close to the November vote out of concern it could be seen as trying to favor one party over the other.

For that reason, many economists said they still believe the Fed will stay on hold until after voters go to the polls in November.

"We have a slight change in wording, but I don't think there will be any change in policy until after the election," said David Jones, head of DMJ Advisors, an economic-consulting firm. "The Fed is not going to act anytime soon to hike interest rates with inflation low and the unemployment rate still high."

The Fed last raised rates in June 2000, when the federal funds rate rose a half-point to 6.5 percent, the last of six rate increases the central bank had begun in June 1999.

Those increases did slow economic growth, but they also helped burst the stock market bubble in early 2000, ending a 10-year economic expansion, the longest in U.S. history.

Alan Greenspan
Seeking to combat economic weakness, the Fed started in January 2001 to cut interest rates. The reductions picked up momentum after the Sept. 11, 2001, terrorist attacks, making 2002 the most aggressive period of rate cuts since Federal Reserve Chairman Alan Greenspan took the top Fed job in 1987.

Most of the rate cuts occurred in 2001, although 2002 saw a half-point cut and a quarter-point cut. The reduction in June pushed the funds rate down to 1 percent, the lowest it has been since Dwight Eisenhower was president.

The Fed had been concerned about the remote possibility that the country's long period of economic weakness could trigger a destabilizing bout of falling prices, or deflation, something last seen during the Great Depression.

In its statement yesterday, the central bank said the upside and downside risks to achieving acceptable economic growth were roughly in balance.

Yesterday's market activity

The Dow Jones industrial average, in positive territory before the Fed's announcement, plunged 141.55 to 10,468.37, erasing nearly all its January gains.

Microsoft, one of the 30 Dow stocks, fell 54 cents to close at $27.71. Boeing, also a Dow stock, was off 40 cents to $41.54.

Broader stock indicators also fell. The Standard & Poor's 500 index was down 15.57 at 1,128.48, and the Nasdaq composite index fell 38.67 to 2,077.37.

Bond prices dropped as well, sending interest rates set by the market sharply higher.

Short-term rates tied to Fed actions did not move at all because the Fed left its target for the federal-funds rate, the interest that banks charge on overnight loans, unchanged at 1 percent. That means commercial banks' prime rate, the benchmark rate for millions of consumer and business loans, remains unchanged at 4 percent, the lowest rate since 1959.

Gold/oil

In U.S. trading, gold gained $4.50 to $414.60 per ounce on speculation Japan might boost the amount of bullion it holds to diversify its foreign reserves.

Oil fell 70 cents to $33.02 per barrel after the government said U.S. supplies would be adequate to meet winter demand.

Material from Reuters is used in this report


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