FOCUS-Fed rates on hold, temporarily, for Y2K

By Glenn Somerville

WASHINGTON, Dec 20 (Reuters) - While virtually no-one expects Federal Reserve policymakers to raise interest rates at their last meeting of the millennium on Tuesday, few expect them to wait long to do so.

Analysts say steady interest rates are almost a foregone conclusion for the current meeting, as the rate-setting Federal Open Market Committee sits out any problems that the Year 2000 computer bug might cause the economy.

"We see no rate move (on Tuesday) but we think another tightening is just around the corner," said economist David Greenlaw of Morgan Stanley Dean Witter in New York. "We expect 25 basis points more (one-quarter of a percentage point) in February." The Fed next meets on Feb. 1-2. With steady rates almost a given on Tuesday, interest focused on the secretive committee's "bias," which the Fed recently started using as a policy tool to indicate its predisposition toward future rate changes.

The U.S. central bank has grown concerned about financial markets' confusion since it started announcing its bias publicly. It set up a committee to study how to improve its communication to markets and speculation has grown that it may make an announcement as early as Tuesday.

"We expect them to institute a new bias announcement policy and to drop any reference to holding either a neutral or a tightening bias," said Greenlaw.

Instead, it will focus on the general state of the economy and on the risks it faced in order to achieve sustained growth, Greenlaw said.

An announcement on interest rates is expected at around 2:15 p.m. (1915 GMT). Any statement about adoption of a new policy on rate biases would likely come at the same time, if the Fed members agreed upon it.

By any measure, the world's largest economy is heading into the new year on an extraordinarily vigorous note, closing in on a record 107 months of steady expansion in February.

Unemployment is near a 30-year low, incomes are rising and consumer prices have remained well-behaved so far.

But with gross domestic product, or total output, booming ahead at a 5.5 percent annual rate of growth in the third quarter, most analysts say the risk is that prices and wages could quickly begin to spin upward amid tight labor markets.

Many say a rate rise would be on the table for Tuesday if not for the "Y2K bug" -- in which computer systems throughout the economy could malfunction because of a possible inability to recognize the year 2000.

Y2K RISKS

The Fed has pushed U.S. financial institutions to make the necessary remedies to avoid such a possibility, but not all trading partners have been as diligent and those doubts were considered enough to stay policymakers from acting.

"Even if the Fed is inclined to raise rates again in the near-term, it just does not make sense for the Fed to be rash given the uncertainty surrounding Y2K here and abroad," Standard and Poor's said in its weekly commentary.

By Feb. 1-2, though, when the FOMC policymakers gather for their first of eight meetings in 2000, the scope of any Y2K-related problems should be apparent so that there will be less restraint against a rate increase.

After three increases this year, the federal funds rate stands at 5.5 percent. The more symbolic discount rate is 5 percent.

Economist Sung Won Sohn of Wells Fargo Bank in Minneapolis, Minn., noted there were valid political and economic reasons for the Fed to be ready to move early next year on rates. That would get rate rises over ahead of the all-out political season leading up to next November's presidential elections.

"A couple of rate rises won't kill this economy and they may inoculate us against future inflation," Sohn said.

"The Y2K season will be over for the Fed by February and the real political season won't begin until spring or late summer, so the Fed will have a fairly narrow window in which to get tightening out of the way and avoid it becoming an issue," he added.

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Ray

-- Ray (ray@totacc.com), December 20, 1999

Answers

The Y2K season will be over for the Fed by February? The functioning of the Fed may be over by February if Y2K is nasty, and what a relief that will be.

-- cody (cody@y2ksurvive.com), December 20, 1999.