Fed holds pat, but interest-rate party isn’t over yet

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Like a bartender a half-hour before closing time, Alan Greenspan has announced last call.

Standing arms akimbo behind the bar, a beer-soaked towel tucked in his belt, the chairman of the Fed says it’s time to drink up before heading out into that cold night.

Which is a fanciful way of saying that Greenspan & Co. have ended their rate-cutting spree of 2001, but there’s still time to indulge yourself because the Fed is unlikely to raise rates soon.

“Signs that weakness in demand is abating and economic activity is beginning to firm have become more prevalent,” the committee said, adding: “the outlook for economic recovery has become more promising.”

Short-term interest rates probably will remain steady for a few months, and long-term mortgages are still a bargain. But what comes down must go up, and eventually the Fed will raise rates. When that happens is anyone’s guess.

The Fed’s inaction marks the first time since December 2000 that its rate-setting body, the Open Market Committee, has left short-term rates alone. Last year the Fed cut the overnight rate 11 times, lowering it from 6.5 percent at the beginning of 2001 to 1.75 percent at the end of the year. It remains at 1.75 percent.

The overnight rate, officially called the federal funds rate, is what banks charge one another for short-term loans to cover their reserves. The Fed sets a target for the overnight rate and controls it indirectly by adding and subtracting cash from the banking system.

The Fed’s actions affect consumers because the overnight rate influences the prime rate, which is what banks charge their best corporate customers. You’re not going to get a loan at the prime rate, but the rates you pay on some types of debt are based upon the prime rate. Many variable-rate credit cards, car loans and home equity lines of credit are tied to the prime rate.

Because the Fed has left the overnight rate alone, the prime rate will stay the same. So will debt that’s based upon the prime rate: those aforementioned variable-rate credit cards, car loans and home equity lines of credit.

Rates for 15- and 30-year mortgages tend to move independently of the Fed’s rate actions. Instead, long-term mortgage rates roughly follow the movements of 10-year Treasury notes. The interest paid on 10-year Treasuries has been ratcheting upward since November.

The operative word is “ratcheting” — mortgage rates have moved up and down from day to day, but have moved more up than down in the last two-and-a-half months. In the Bankrate.com weekly index of large lenders, the national average 30-year rate bottomed out at 6.42 percent on Nov. 7 and now stands at about 7 percent.

Mortgage rates probably will stay at this level for a while, says Doug Duncan, chief economist for the Mortgage Bankers Association.

“We see in the first half of the year that the 30-year mortgage rate will be in the 7- to 7.1-percent range, and as the recovery takes hold, they’ll go a little higher,” he says, adding that he doesn’t expect them to go much higher even then.

Few were surprised that the Fed kept the overnight rate steady. Greenspan hinted as such on Jan. 24, during testimony to the Senate. In remarks about the state of the economy, Greenspan told the senators that there were signs that the worst of the recession had passed, but that not all of the economic news was good. Above all, he said he didn’t want to sound either too optimistic or too pessimistic.

Then, on Wednesday morning, the government announced that the national economy expanded during the last three months of 2001. That surprised most economists, who had expected a contraction. The economic data all but sealed the fate of the Fed’s rate-cutting streak.

Observers’ attention then turned to another key paragraph of the announcement — in which the Fed says whether it thinks the economy is getting stronger, getting weaker, or on an even keel.

All last year, the Fed said it believed the economy was at risk of weakening further. That’s why it continued to cut short-term interest rates — a policy that didn’t prevent a recession, but almost surely kept the recession from getting worse.

The Fed didn’t change the wording this time, indicating that it’s still worried that the economy could worsen. By not changing the wording, the Fed is hinting that it might lean toward lowering the overnight rate the next time it meets, in March. That’s not a sure thing, though — the last time the committee met, on Dec. 11, it said the economy was at risk of weakening further, but it didn’t cut rates this time.

But the Fed tempered that statement, saying that the outlook for recovery is more promising than it was a month ago.

The Fed kept the seldom-used discount rate at 1.25 percent. The discount rate is what the Fed charges banks to borrow reserves directly from the central bank.

The Fed’s open market committee schedules eight meetings a year. Its next scheduled meeting is March 19.