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December 20, 2000

Fed Abandons Anti-Inflation Stance, Leaves Short-Term Rates Unchanged
By David Wessel And Gregory Zuckerman, The Wall Street Journal

Fear of Inflation Torpedoes Any Cut in Interest Rates ... Weiss comments

WASHINGTON - The Federal Reserve promised to throw a life preserver to the U.S., declaring that the risks of "economic weakness in the foreseeable future" exceed the risks of inflation. But it left short-term interest rates unchanged.

Financial markets now expect the Fed to begin cutting rates at the end of January, and to reduce them at least one-half percentage point by spring.

Abandoning its 19-month stance that it was primarily worried about "inflation pressures," Fed officials ended their meeting with a statement saying, "The drag on demand and profits from rising energy costs, as well as eroding consumer confidence, reports of substantial shortfalls in sales and earnings, and stress in some segments of the financial markets suggest that economic growth may be slowing further."

Although "some inflation risks persist," the Fed added, "they are diminished by the more-moderate pace of economic activity and by the absence of any indication that longer-term inflation expectations have increased." In contrast to recent Fed statements, this one included no mention of the inflationary dangers of tight labor markets.

You bet inflation risks persist. That's why the Fed didn't dare lower interest rates. They know that energy prices are poised to skyrocket. Oil and natural gas inventories remain near record lows. Winter weather has hit the U.S. with gale force -- parts of the Midwest have already seen record snowfall levels -- and will inevitably tax energy supplies even more. On top of this, OPEC wants to cut production so that it can boost oil prices for a bigger profit.

Any move by the Fed to cut rates would ignite an upward spiral of inflationary pressures, sending the dollar into a tailspin, and prompting overseas investors to run for the exits. In fact, just a hint that the Fed may cut rates has already resulted in this. The euro surged to a four-month high against the dollar as legions of overseas investors have begun the exodus out of the U.S. stock and corporate bond markets. This will trigger inflationary pressures as overseas investments no longer shield the economy from America's enormous trade deficit.

It's no wonder why the stock market continued on its downward spiral today. As inflationary pressures mount, it will become less and less likely that the Fed will cut rates. And the market is still saddled with an ever-growing list of companies reporting disappointing earnings and projecting an even harder road ahead.

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