Fed hopeful about economy as oil prices drop

washingtontimes.com By Patrice Hill THE WASHINGTON TIMES

     The Federal Reserve, against a backdrop of plunging oil prices, was guardedly optimistic yesterday that the clouds cast over the economy by near-record oil prices and the Iraq crisis will soon lift.      After a daylong meeting of its rate-setting committee, the central bank said it had "heightened surveillance" to gauge the economy's response to the sudden drop in oil prices and other developments precipitated by the Bush administration's move toward war.      "The hesitancy of the economic expansion appears to owe importantly to oil price premiums and other aspects of geopolitical uncertainties," the committee said in a statement. "As those uncertainties lift," the economic climate should improve, it added.      The sharp rise in stock prices and unexpectedly big drop in oil rates this week to under $32 a barrel in New York trading appeared to vindicate Federal Reserve Chairman Alan Greenspan's prediction of a quick economic rebound once a decision is made on Iraq.      But the Fed yesterday was careful to add that it cannot predict the course of the war and, thus, its lasting effect on the economy, and that the reserve is poised to respond whichever way the situation goes. The Fed did not act on interest rates.      A good part of the "war premium" on oil prices referred to by the Fed, which drove prices close to $40 late last month, evaporated in the past two days on hopes that the war will go according to Bush administration plans and end quickly. Yesterday, prices plummeted more than 9 percent to $31.67 in New York trading.      The drop did not occur in time to prevent gasoline prices at the pump from hitting a record high last week, however. The shock from high gas prices and home-heating bills is one of the biggest threats that economists say could trip the weak economy back into recession.      The run-up in energy prices this year "has been at least comparable — and perhaps larger than — the spike that preceded the 1990-1991 Gulf war" and recession, said Mickey D. Levy, chief economist with Banc of America Securities.      Mr. Levy noted that the jump in energy prices for consumers has been almost identical to the rise that helped push the economy into recession in 2001, and that the drop in oil prices this week did not come a moment too soon.      But he expects energy prices to remain elevated and pose difficulties for the economy, even if the war in Iraq goes smoothly.      "[Organization of the Petroleum Exporting Countries] quota reductions in early 2002 and the persistent disruption of Venezuela's oil production have been key influences that are not likely to quickly reverse even with the discharge of some of the Gulf tensions," he said.      Gasoline prices may be slow to respond to the plunge in oil prices this week, because stocks are near their lowest levels in three decades.      The available oil has been diverted more into production of home-heating fuel than has been customary owing to the severely cold winter, reducing the oil available to build gasoline stocks for the summer driving season, Mr. Levy said.      While high energy prices have been cutting into consumers' purchasing power, they also have had a marked effect on consumer psychology. Consumer confidence is at the lowest level in a decade.      A survey released yesterday by the NPD research group found that nearly half of consumers plan to cut their discretionary spending because of high gas prices.      That is more than twice the number that said they would trim spending and family outings because of fears about war or terrorism, the group said.      "Not only are people cutting back on big-ticket items, but they are also spending less on relatively inexpensive entertainment activities like dining out," said Jon Swallen, senior vice president at Universal McCann, a private research group that recently documented a drop in consumer buying plans.      Travel spending is taking a disproportionate hit, he said, with a third of consumers saying now is a bad time to fly or take a vacation trip.      Spending has been the engine of the economic recovery in the past year, and any big pullback by consumers in response to high energy prices or war in Iraq threatens economic growth, analysts say.      One war-related problem that developed during the Gulf war was the so-called "CNN effect," as consumers stayed home and watched the Iraq developments unfold on the 24-hour cable television network. That resulted in a big drop in consumer spending that drove the economy closer to recession.      That is why the Fed is following closely reactions to developments in the Middle East, and is prepared to cut interest rates immediately, if necessary, to provide another prop for consumers, said Joel Naroff of Naroff Economic Advisers.