Cooling Economy Could Stabilize Rates

The economic boom that peaked late last year is fading and not expected to extend into 1995. But analysts say the more moderate growth could convince the Federal Reserve to hold down interest rates - perhaps even lower them this summer.

“The economy either will have a soft landing or a somewhat harder landing. In either case we should see long-term rates benefiting due to softer economic conditions,” predicted economist Sung Won Sohn of Norwest Corp., a Minneapolis bank.

The Commerce Department reported Friday that gross domestic product, the government’s most comprehensive economic gauge, rose at a strong 5.1 annual rate in the fourth quarter last year. For all of 1994, the economy posted its best performance in a decade.

While the fourth-quarter figure was revised upward from an earlier estimate, most analysts said there is little reason to fear inflation and that growth already has slowed considerably. Official first-quarter reports are not yet available.

The Federal Reserve began raising short-term interest rates in February 1994 and since then has boosted them seven times, doubling one key rate from 3 percent to 6 percent. Banks have followed suit, raising their benchmark prime lending rate accordingly.

But last Tuesday, the Federal Open Market Committee - the central bank’s policy-making body - decided at a private meeting to leave rates unchanged, a decision seen by many economists as an indication that the rise in rates, for now, may be over. The panel next meets May 23.

The higher rates approved earlier are still reverberating through the economy, pushing up borrowing costs for businesses and millions of ordinary Americans. Interest-sensitive areas such as purchases of homes and cars have been hit particularly hard.

The Fed’s intent was to squelch inflation before a dangerous upward spiral began and to trim economic growth to around 2.5 percent. The rate increases, along with a Mexican peso crisis that has cut into U.S. exports, appear to be having the desired effect.

Many analysts believe economic growth slowed to around 2 percent to 2.5 percent during the first quarter of 1995, which ended Friday. Preliminary government figures for the January-March quarter will not be available until April 28.

“The Fed is pretty much on target,” said economist Michael Evans, who heads his own forecasting service in Boca Raton, Fla. “They probably waited too long to tighten in the first place. But they’ve done a pretty good job.”

Evans said Federal Reserve Chairman Alan Greenspan and his colleagues may be reluctant to lower rates in the coming months, but he predicted as the data pile up, they will become convinced the trend toward moderate or lower growth is lasting. Lower rates could be in the cards by the time of the late August meeting of the Federal Open Market Committee, he said.

But other analysts expect inflationary pressures to mount if the economy heats up again.

“As long as employment grows, the consumer will be right back spending. The economy will sustain its momentum,” said economist Eugene Sherman. “The Federal Reserve will have no choice but to tighten again.”

Inflation has been below 3 percent for the last three years. It is expected to increase somewhat this year, but nowhere near the point of a runaway wage-price spiral.