Donna Block
SHARE WORLD
Will he or won’t he, will he or won’t he? This has been the refrain from economists, analysts and investors this week as they awaited news on whether United States central banker extraordinaire, Alan Greenspan, was going to join his peers and raise short-term interest rates, or not.
In the past week central bankers from Britain, Australia, and the European Central Bank decided it wasn’t a bad idea to raise the cost of their banks’ overnight funds just in case inflation decided to rear its ugly head.
In the US, the biggest question facing the 10 voting members of the secretive Federal Open Market Committee (FOMC) was how are they dealing with the world’s biggest economy, after more than eight years of expansion? Would the economy eventually slow down by itself? If the answer is yes, rates should be left alone. If the answer is no, rates should be raised to keep the economy from overheating. Well, the answer was no and the Fed raised overnight interest rates by a quarter percentage point.
This is the third rate hike this year and removes the last of the extra liquidity that was added to the money supply a year ago when global financial markets appeared to be on the brink of disaster. It’s also a signal that the Fed wants to temper the US economy’s momentum, which is now only months away from reaching the status of the longest economic expansion in history. Despite rate rises in June and August aimed at reining in growth, the economy has shown only scattered signs of slowing.
In a statement explaining its decision, the Fed emphasised its concern that the country is running out of workers and this will inevitably force wages higher, thus forcing prices to increase and endangering the economic expansion. Another factor in the decision is that some at the Fed are disconcerted by an upward trend in commodity and import prices. These factors bolstered the case for nudging up rates as a precaution against future inflation. The committee also said that while there has been some slowing of economic activity, worries remain that the pace of growth ”continues in excess of the economy’s growth potential”.
Businesses and consumers will feel the sting immediately; banks started raising their prime lending rates soon after the announcement was made, increasing rates on credit cards and a variety of consumer loans including mortgage bonds.
The Fed also hinted that it will not raise rates again this year as the three increases since June ”should markedly diminish the risk of inflation going forward”. However, it did leave open the possibility of raising rates further next year if the economy keeps growing at a blistering pace and unemployment continues to fall.
In its statement the central bank said it was removing its stance towards higher rates – a tightening bias – to a neutral bias, signalling that there would not be a rate increase at its next monetary policy meeting on December 21. This news prompted investors – who took this to mean no more rate increases before the Fed’s first meeting in February 2000 – to pile into the stock market and drove the Dow Jones industrial average to its highest level in two months and the Nasdaq – which is up 50% this year – to another new high.
But even before this week’s statement suggesting that the Fed will be on hold for the rest of the year, many analysts had expected rates to remain untouched for several months because of the insecurity surrounding the Y2K computer bug and what effect it will have on the economy and the financial system. The Y2K computer problem is expected to cause some distortions to economic numbers as businesses build extra inventory and consumers hold on to more cash than they would in normal circumstances, making it difficult for central bankers to get accurate data during December and in early 2000.
Some analysts also suggest that rates could drop in December, January and February, as global capital inflows may increase if the US is seen as a safe haven during this time of uncertainty. However, uncertainties abound. The year 2000 will bring a new president to the US – and already there are those who are wondering if Greenspan will ”lean” towards accepting another appointment as head honcho of the Fed.