Feds unlikely to Raise Interest Rates

The U.S. economy probably closed out 2009 with the fastest growth rate in nearly four years, yet it won’t be enough to tempt the Federal Reserve to lift record-low interest rates.

The initial look at fourth-quarter gross domestic product comes on Friday, and economists polled by Reuters are expecting it to show the economy advanced at a 4.5 percent clip. That would be double the rate in the third quarter, when the economy resumed growing after four consecutive quarters of declines.

Beneath the veneer, however, the recovery still looks fragile. A 4.5 percent annualized rate of growth would be the strongest since the first quarter of 2006, but the economic drivers look very different.

Back then, before the financial mess made borrowing costlier and scarcer, consumers and businesses were busy buying expensive items such as cars and office buildings. Final sales, a closely watched measure of the economy that strips out the impact of inventories, rose at a 5.9 percent rate.

In the latest quarter, the lion’s share of growth likely came from changes in business inventories. Economists in the Reuters poll think final sales rose at a modest 1.6 percent pace. That helps explain why more than 200,000 jobs were lost last quarter even though growth was probably above average.

For the Fed, which begins a two-day policy-setting meeting on Tuesday, those job losses suggest it will be some time before interest rates rise from the current level near zero.

The U.S. central bank has two responsibilities: promoting full employment and keeping inflation in check. The high jobless rate means the Fed is far from accomplishing its first goal. It also means labor costs will remain low, giving the Fed a helping hand on the second one.

In a December speech to the Economic Club of Washington, Fed Chairman Ben Bernanke spoke of the weak labor market among the “formidable headwinds” to recovery.

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“With unemployment rates likely to remain well above 9 percent past the end of this year, and credit creation continuing to be constrained by tight lending standards, home foreclosures and balance sheet restructuring, Bernanke’s formidable headwinds could easily keep the Fed on hold well into next year,” said Michael Gregory, senior economist with BMO Capital Markets.

Bernanke himself is up for confirmation on his second term as Fed chairman, and the Senate vote — coming as early as this week — looks very tight. Some lawmakers blame Bernanke for missing the warning signs of the financial crisis and mishandling the rescue, particularly the costly bailout of insurer American International Group [AIG  26.50  -1.05  (-3.81%)   ].

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Bernanke has also been criticized for being slow to recognize trouble brewing in the housing market and its potential to wreck the broader economy.

Real estate’s still-lingering woes will be on full display this week.

Monday’s report on existing home sales is expected to show a decline from the prior month. The next day, Case/Shiller home price data is likely to be flat or lower. Wednesday’s new home sales may be up slightly from November’s depressed levels.

David Rosenberg, chief economist with money manager Gluskin Sheff, said the Case-Shiller data in particular “looms very large.” He thinks home prices may fall another 10-15 percent this year because of a huge supply of unsold homes.

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“Few are braced for such a prospect,” he said.

Rosenberg pointed out there were 2 million U.S. homes vacant and for sale, 3.4 million that were vacant but off the market, and 3.5 million occupied but listed for sale.

“So we have a supply, both potential and actual, of over 9 million homes and condos nationwide,” he said. “That is a huge overhang.”

The United States was not alone in experiencing a swift run-up in property values followed by a painful bust. Britain also had a housing boom and its economy is paying the price.

Its fourth-quarter GDP figures are due on Tuesday and are likely to show an advance after six quarters of contraction, making Britain the last of the major developed economies to break out of the global slump.

Canada’s fourth-quarter GDP is also coming this week, and will probably show a slight increase.

However, 2010 growth forecasts remain muted across the major economies. In the United States, economists polled by Reuters thought GDP growth would slip back to around a 2.7 percent rate this year despite the strong finish to 2009.

“While the recovery may look better than it feels, it is a recovery nonetheless,” Wells Fargo economists wrote in a note to clients. “Our growth outlook: slow and steady.”

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