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Election Could Delay Fed Rate Rise Until December

July 3, 2008 by  


By Alister Bull

2008-06-26T000703Z_01_NOOTR_RTRIDSP_2_BUSINESS-USA-FED-RATES-DC WASHINGTON (Reuters) – The Federal Reserve may be hesitant to raise interest rates ahead of the U.S. election in November, although there is no hard evidence to support the widely held view that politics influences monetary policy.

The Fed has raised rates in election years, as well as leaving them on hold or cutting. As a result, there is no pattern to confirm the strong sense that the central bank prefers to hold fire as Americans go to the polls.

Nonetheless, economists say the case for rate increases would have to be particularly convincing for the Fed to act.

“The Fed will want to be as low-key and invisible as possible and that means the Fed will not want to change the funds rate ahead of the election,” said William Poole, who retired in March as president of the St. Louis Federal Reserve Bank after a decade on the Fed’s rate-setting committee.

“But I believe that if there is a compelling case, the Fed will do so,” he said. “I do not believe the Fed will abstain from necessary policy action because of the election.”

Some see political calculations delaying Fed action until after the November 4 presidential election to the central bank’s first post-vote policy meeting on December 16.

“We’re facing an election, and the Fed usually tries to stay on the sideline,” said Henry Kaufman, a veteran observer of the U.S. economy and former chief economist with Salomon Brothers in the 1970s and 1980s.

“I doubt whether the Federal Reserve will, as it is now structured, have the strength within its voting power to say we’re going to go up 50 basis points, 50 basis points, 50 basis points,” Kaufman told Reuters earlier this month, referring to the possibility of a series of half-percent point moves.

Interest rate decisions are subject to a vote by members of the Federal Open Market Committee. The ballot is split between the presidentially appointed members of the Fed’s Board of Governors in Washington and five of the 12 regional Federal Reserve bank presidents.

Insiders deny politics influences their decisions. But there is no doubt moving rates in an election year can make the Fed either hero or goat from a political perspective, earning the ire of the party that feels central bank action — or inaction — cost it votes.

Former President George H.W. Bush famously blamed then-Fed Chairman Alan Greenspan for not lowering rates more aggressively as he campaigned for re-election in 1992.

That was the year in which “It’s the economy, stupid” became Bill Clinton’s winning slogan.

“I think that if the interest rates had been lowered more dramatically, that I would have been re-elected president because the recovery that we were in would have been more visible,” Bush told British interviewer David Frost in an interview aired in 1998.

“I reappointed him, and he disappointed me.”

The current Fed under Chairman Ben Bernanke slashed benchmark overnight rates to 2 percent in seven steps that began in September.

But it is now increasingly worried about inflation in the face of surging food and energy prices, and last week it halted the rate-cut campaign and hardened its warnings on prices.

Investors think this means the next move in rates will be up, and see almost an 80 percent likelihood of a quarter-point rise by the Fed’s meeting at the end of September.

Some economists, concerned the economy is still fragile, think it will take longer for growth to recover and argue against hasty rate action.

In particular, they worry that more than $100 billion of economic stimulus checks the government is sending households will deliver only a temporary fillip to consumer spending.

Once that money runs out, the economy could stumble, and they think the Fed will want to watch spending behavior over the summer and early fall before raising rates.

Data on Friday showed that stimulus checks had pushed consumer spending up by a sharper-than-expected 0.8 percent last month and pushed up disposable personal income by the largest amount since 1975.

Economists at JPMorgan saw this doubling second-quarter U.S. growth to a 2 percent annual pace, but they warned it would fall back to 1 percent in the third quarter.

As the Fed weighs inflation and growth risks, it has only three more scheduled meetings before the presidential election — August 5, September 16 and October 28-29.

If Bernanke trusts his forecast that inflation will moderate as the rapid gains in energy prices subside, and wants to give the economy a chance, he could hold off tightening monetary policy until the post-election meeting on December 16.

“They’re not going to do anything in October, a week before the election, so I think they are on hold,” said John Silvia, chief economist at Wachovia, the fourth-largest U.S. bank.

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