Tuesday, June 03, 2008


Fed signals end to rate cuts TheStar.com -

Business - Fed signals end to rate cuts

May 25, 2008 JEANNINE AVERSAAP Economics Writer

WASHINGTON (AP) – Sounding a gong couldn't have made it clearer. Federal Reserve officials are putting out the word that further interest rate cuts are unlikely.
Fed Governor Kevin Warsh ditched the central bank's cryptic word tangles and actually waxed poetic. "Even if the economy were to weaken somewhat further, we should be inclined to resist expected, reflexive calls to trot out the hammer again," Warsh said, referring to the Fed's key interest rate.
Speaking more central-bankerly, the Fed's No. 2 official, Vice Chairman Donald Kohn, said the current stance of interest-rate policy "appears to be appropriately calibrated for now." Janet Yellen, president of the Federal Reserve Bank of San Francisco, called the current level of rates "appropriate.''
They are amplifying a signal sent by Chairman Ben Bernanke and his colleagues last month that the Fed's most aggressive rate-cutting campaign in two decades may be winding down – finally. The cuts started in September and take months to work their way through the economy.
That does not mean the economy, badly bruised by housing, credit and financial woes, is out of the woods. The Fed, though, is hoping its powerful doses of cuts, along with the government's relief plan of tax rebates and breaks will help lift the economy in the second half of this year.
Zooming prices for energy and food and other commodity prices are raising some concerns that inflation could take off and spread through the economy. Further reductions in interest rates would aggravate the situation.
In fact, the Fed's last rate reduction in late April was "a close call," according to recently released documents of those private deliberations. At that time, two Fed members favored no cut at all, given the concerns about inflation.
Many economists believe the Fed will hold its key rate steady at 2 percent, a four-year-low, at its next meeting on June 24-25 and probably through much, if not all, of 2008.
Holding rates at this level should help foster better economic and employment conditions and moderate inflation, Kohn said.
"The Fed's advertised reluctance to cut again is a wise one,'' said Terry Connelly, dean of Golden Gate University's Ageno School of Business.
Here's what Fed policymakers are up against: Cut rates and bolster a weak economy where employers are eliminating jobs and consumers are pulling back; raise rates and fend off inflation.
With the housing market still flailing and foreclosures at record highs, policymakers probably would shy from pushing up rates – even with the specter of inflation – as the country prepares to vote for a new president, some analysts said.
"The Fed has spent the last eight months ushering homeowners with adjustable-rate mortgages to safety by repeatedly cutting interest rates. They won't want to throw them back under the bus by raising interest rates too much, too soon," said Greg McBride, senior financial analyst at Bankrate.com. "Candidates would have a field day," he said.
Bernanke has said the election would not color the Fed's decisions. "Political considerations will play no role. We will be objective. We will be analytical, and we will do what is right for the economy," he said.
The Fed's political independence is crucial to its ability to maintain credibility with investors on Wall Street and around the globe.
The combination of slow growth and rising inflation has raised fears the country may be headed for a bout of stagflation for the first time since the 1970s. Bernanke and other Fed officials, however, say that is not the case.
Oil prices are marching past $130 a barrel, gasoline prices are closing in on $4 a gallon nationally and food prices are skyrocketing. Given all that, Fed officials cannot afford to let inflation take hold. Once that happens, it can be difficult and painful to break inflation. It could force the Fed to raise rates, which would puts the brakes on spending. Inflation eats into paychecks, whittles away the value of investments and cuts into corporate profits.
"Inflation has been elevated for some time and prices of commodities are surging," Warsh said. "I find these trends particularly vexing at a time when global demand growth, most likely, has slowed," he said.
The Fed's rate reductions since last year have contributed to the drop in value of the dollar. The diminished greenback has been a factor pushing up prices for oil and other commodities. Kohn, however, believed the sagging dollar's role in rising commodity prices "probably has been a small one.''
For now, the Fed is forecasting slower economic growth, higher unemployment and a bigger pickup in inflation for this year than it thought just a few months ago. But Fed officials acknowledge the uncertain environment makes them less confident in their projections.
And conditions can change quickly.
In October the Fed signaled it was going to hit the pause button on rate-cutting campaign. At the time, Fed officials believed additional cuts might not be needed to help the economy survive housing and credit stresses. Then conditions deteriorated, forcing the Fed to do an about-face and lower rates again in December.
AP-ES-05-25-08 1055EDT

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