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Fed's semantics trigger retreat

The Federal Reserve left short-term interest rates at just 1 percent, the lowest level since 1958, Wednesday but retreated slightly from past declarations that it would keep rates low for "a considerable period."

The slight shift in tone, however, may well amount to a distinction without a difference. In a statement following the monthly meeting of the Federal Open Markets Committee, the central bank noted that inflation continued to be "quite low" and that monetary policy could continue to be "patient."

The shift in wording unnerved both the stock and bond markets.

The Dow Jones Industrial Average, which had been in positive territory before the Fed's afternoon announcement, ended the day down 141.55 points at 10,468.37, a 1.3 percent drop that erased nearly all of the Dow's gains since the beginning of the year. The Standard & Poor's 500 index was down 15.57, or 1.4 percent, at 1,128.48, and the Nasdaq composite index was down 38.67, or 1.8 percent, at 2,077.37.

Bond prices dropped, too, sending interest rates higher. The yield on Treasury's 10-year note climbed to 4.19 percent, up from 4.08 percent the previous day.

Most if not all economists had expected the Federal Reserve to leave its overnight federal funds rate unchanged, but they were less certain about what it would hint about future policy in the months ahead. The greatest speculation had been on whether the Fed would continue to promise low rates for "a considerable period," and many experts had expected it to keep that open-ended commitment for another month or so.

Although reports Wednesday said orders for big-ticket goods were flat in December after taking a dive in November and the pace of new-home sales also slowed last month, the Fed's announcement came at a time when almost all indicators point to very strong economic growth.

The federal government will release its first estimate of growth in the fourth quarter of last year on Friday, and the consensus prediction among forecasters is that growth could be at or near an annual rate of 5 percent.

That would be slower than the third quarter of last year but much faster than seemed likely just a few months ago. The Fed implicitly acknowledged the faster growth in its statement, but it made clear that senior officials were still nervous about the sluggish pace of job creation and the fairly large percentage of unused factory capacity.

Wednesday's snapshot of manufacturing activity reported by the Commerce Department disappointed economists, who were forecasting a solid 2 percent rebound in orders for costly manufactured goods in December. The flat reading in orders for durable goods followed a 2.3 percent drop in November. That weak performance raised questions about how firm a grip manufacturers had on their own recovery.

Commerce also said sales of new homes ended 2003 on a lackluster note, declining by 5.1 percent in December from November. Economists were forecasting a rise. The weakness was concentrated in the West and the South.

For all of 2003, however, home sales reached a record high of 1.09-million as low mortgage rates beckoned buyers. That represented an 11.5 percent jump from 2002, the previous best year ever for sales. The average sales price of a new home last year was $244,800, a record high and up from $228,700 in 2002.

After its policy-setting meeting last month, the Federal Open Market Committee created a buzz in the financial markets by declaring that the chances of an "unwelcome fall in inflation" had diminished and were almost equal to the risks of a rise in prices. That suggested the central bank was preparing the way for rate increases in the future, but Fed officials have made it clear since then they still view inflation as almost non-existent and they want to see a greater decline in unemployment.

In the parlance of Alan Greenspan, the Fed's chairman, the central bank remains worried about "slack" in both the job market and industrial capacity. Job creation essentially came to a halt in December, according to the Department of Labor, which raised new doubts about the prospects for a significant drop in unemployment from its current level of 5.7 percent.

Economists inside and outside the Fed were also surprised when the government reported that consumer prices climbed at an annual rate of barely 1 percent in December. Although Greenspan has refused to embrace any explicit targets for an acceptable rate of inflation, several Fed governors have suggested that they are uncomfortable with "core inflation" _ excluding the volatile prices for food and energy _ that is below 1 percent.

"The rate of inflation is extremely low, arguably lower than they would like to see it," said Joshua Feinman, chief economist at Deutsche Asset Management in New York. "Combined with the notion that the economy still has some degree of slack in the labor and capital markets, that makes them a little uncomfortable."

The Fed has kept the federal funds rate for overnight loans at 1 percent since last summer. At the time, the economy still seemed to be swooning from uncertainty associated with the war in Iraq and continued reluctance among business executives to invest in new equipment or hire additional workers.

But the economy surged last summer, expanding at an astonishing annual rate of 8.2 percent in the third quarter _ the fastest pace in 20 years. Still, the increase was fueled in large measure by last year's big tax-cutting package, and it remained unclear whether the growth would continue once the impact of the extra cash in people's pockets began to fade this year.

Economic growth now appears to have remained very strong during the last three months of 2003, and economists have raised their estimates for growth through the end of this year to about 4.6 percent.

Coming out of past recessions, that kind of growth would have been more than enough to provoke the Federal Reserve into raising interest rates. But inflation was always running higher than the Fed considered desirable after previous recessions, which is why the central bank always felt nervous about leaving money too cheap for too long.

As a result, most economists had been expecting the Fed to reiterate past statements that it will keep interest rates low for "a considerable period." Fed officials have tried to emphasize that they are not trying to define their policy in terms of a particular time period. Instead, they have said their focus is on how the key issues of inflation and joblessness develop.

_ Information from the New York Times and Associated Press was used in this report.

WORDING CHANGES

The Federal Open Market Committee changed some of the wording in its policy statement Wednesday compared with its statement of Dec. 9. The change that seems to have carried the most weight:

Dec. 9

. . . However, with inflation quite low and resource use slack, the Committee believes that policy accommodation can be maintained for a considerable period.

Wednesday

. . . With inflation quite low and resource use slack, the Committee believes that it can be patient in removing its policy accommodation.

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