Fed Funds Rate Expected to Remain at 5.25%

The Prime Rate follows the Fed Funds Rate.  If you have a home equity line of credit, you’d like this rate to drop.  Consensus is that the Federal Open Market Committee will not lower the Fed Funds rate in their meeting this week nor will they raise it.  Your equity line rate will remain the same according to consensus estimates.

Fed Won’t Change Rate Without Convincing Data

By John M. Berry

May 4 (Bloomberg) — Federal Reserve officials, confronted with conflicting evidence about where the U.S. economy is headed, won’t change the 5.25 percent key interest rate at their policy-making meeting next week.

The Fed board members can’t be sure that economic growth will rebound in the second half of the year, nor whether core inflation will subside gradually as they have hoped.

While the officials are less than certain about their forecast, they also have no strong reason to change it. Until convincing evidence emerges one way or the other, the overnight lending target set last June won’t budge.

Some analysts are predicting there won’t be a surge in growth — and that the Fed will lower the rate to 4.5 percent by the end of the year. That won’t happen unless it’s clear that core inflation is slowing.

The drop in gross domestic product growth in the first quarter to a 1.3 percent annual rate from 2.5 percent in the last three months of 2006, reported on April 27, wasn’t a big deal for most Fed officials. Final sales to domestic purchasers — a measure of total demand within the country — continued to rise at a 2 percent pace, the same as in the second half of last year.

Meanwhile, the Fed’s preferred inflation measure — the core personal consumption expenditure price index — was unchanged in March after larger increases in January and February. As a result, the 12-month change dipped back to 2.1 percent, barely above the 2 percent upper limit of the so-called comfort zone of Fed Chairman Ben S. Bernanke and several of his colleagues.

What’s Next?

The problem is that participants at the May 9 meeting of the Federal Open Market Committee can’t be sure what comes next.

For example, residential investment fell at a 17 percent annual rate in the first quarter — the third consecutive drop of that magnitude — and clipped almost a full percentage point from the quarter’s growth.

Janet Yellen, president of the San Francisco Federal Reserve Bank, said in an April 26 speech in New York that housing has had a significant depressing effect on real GDP growth.

“While I wouldn’t be surprised to see it begin to turn around in the latter half of this year, I also wouldn’t want to bet on it,'’ she said.

Nevertheless, at a conference in Washington on April 28, Yellen said, “I think that it is quite likely that the U.S. economy will pick up steam and get back to trend before 2007 is over.'’

Surprisingly Strong

Quite likely, though far from certain.

On the other hand, some data this week were surprisingly strong, including the Institute for Supply Management’s index for conditions in the manufacturing sector. That index jumped to 54.7 last month from 50.9 in March, a far stronger reading than analysts had expected. A figure of more than 50 indicates expanding factory activity.

Norbert J. Ore, head of the ISM’s Manufacturing Business Survey Committee, said, “New orders and production improved significantly as did employment. Manufacturers are now in their ninth month of inventory reduction, so supply chains are generally in balance.'’

If Ore is right, one drag on growth could be gone. A decline in private inventories cut more than a percentage point off GDP growth in the fourth quarter and reduced the first- quarter number by three-tenths of a point.

A report on factory orders in March also suggested that business investment in equipment and software might be strengthening a bit, as Fed officials have been expecting.

`Going Gangbusters’

In any event, there is no rush to cut the lending rate target out of concern for overall economic weakness. And there isn’t likely to be a cut until there is an answer to a question Yellen asked in her New York speech: “Why is the labor market apparently going gangbusters, while growth in real GDP has turned in only a middling performance?'’

Even though she isn’t a voting member of the FOMC this year, as a former Fed board member and a chairman of President Bill Clinton’s Council of Economic Advisers, Yellen’s views carry significant weight in the committee’s discussions.

You can be sure that details of today’s employment report will be scrutinized in great detail by the Fed.

One month’s figures, even on such an important set of indicators, won’t be enough to change the outcome of next week’s meeting. The same can be said about the April 30 report that core consumer prices were little changed in March.

In summarizing her inflation forecast, Yellen said in New York, “I do expect the dissipation of upward pressure from energy prices and rents and the beneficial effects of anchored inflation expectations to bring inflation down modestly over 2007.'’

Waiting and Watching

She also cautioned, however, “The inflation situation remains uncertain and, in particular, there are upside risks to my outlook, especially having to do with the situation in labor markets.'’

And where does that leave her going into next week’s meeting?

“I would say that, in these circumstances, with heightened risks to both growth and inflation, the best course for policy is watchful waiting,'’ Yellen said.

She emphasized, as do all Fed officials in their speeches, that she was only speaking for herself. Still, few if any of her colleagues might not have said the same thing.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net .

Last Updated: May 4, 2007 00:10 EDT