As the Federal Reserve's main policymaking body met behind closed doors this week, economists are predicting that the central bank will push interest rates down over the next six months in order to keep the economy out of a recession.
The Federal Open Market Committee met Monday and Tuesday to discuss whether to raise or lower interest rates in a delicate effort to balance competing dangers of inflation and recession.Most economists believe that staving off recession will take top billing over inflation on the Fed's agenda.
"We won't get a recession, but growth will be slow enough that that will be the Federal Reserve's concern - preventing recession, more so than fighting inflation," said Darwin Beck, financial analyst at First Boston Corp.
Economists expect the Fed to engineer a quarter of a percent drop in the federal funds rate late this summer, followed by at least one more move from the current target rate that economists say is 8.25 percent.
The federal funds rate is the closely watched rate at which member banks loan money to each other for overnight cash needs. The free-floating rate is also considered a benchmark for other rates in the economy.
A few economists believe the Fed could ease the federal funds rate three or more times before year-end, though no move is expected immediately after the Fed meeting.
If the funds rate eases the half a percentage that most economists foresee, banks would then likely cut their 10 percent prime lending rates, economists said.
The direction of the federal funds rate also indicates what might happen to another crucial Fed tool for influencing the economy, the more visible discount rate. This is the rate at which the Fed lends money to its member banks for overnight needs, and as a rate set by the Fed, is used by them to make clear statements about what they want to happen to interest rates.
Economists said a discount rate move would depend on how close the Fed thinks the economy is to recession. If a clear signal is needed, the Fed would cut the mostly-symbolic rate from its 7 percent level. Also if the federal funds rate nears, or falls below 7 percent, the discount rate would also be cut.
Consumer buying appears to be the key to economic performance in the second half of 1990, economists said. After three months of declines in retail sales, they say that slow consumption will lead the economy too close to a recession for the Fed's comfort. Consumption comprises two-thirds of U.S. gross national product.
"The consumer is the swing factor," said Douglas Schindewolf, associate economist at Smith Barney, Harris Upham and Co.
Economists point to several signs that consumers are holding back their spending.
Housing starts have slumped from a high of 1.57 million units annualized early this year to 1.21 million in May. Auto sales fell from an annual rate of 7.5 million in January to 6.8 million in June.
Manufacturing and exports continue to help, throwing a vigorous note into an economy that otherwise has a weak tone.
But analysts also point out that the economy has limited room for expansion, noting that factories are operating at a fairly high 84 percent of capacity and unemployment is just 5.3 percent of the work force. This means that lower interest rates could serve only to push up inflation.
Because resources remain tight, inflation has not given up much ground, economists said, and therefore the Fed will try to hold credit policy steady as long as possible.
"The Fed wants to get as much mileage as it can on the inflation side before easing," said Robert Chandross, chief economist at Lloyds Bank Plc. "As long as the economy holds in, they have the incentive to stay put."