Fed Faces Tough Call On Rates Due To Recession Fears

Source : The Business Times, September 17, 2007

Analysts expect benchmark rate to be cut by 25-50 basis points

(WASHINGTON) Federal Reserve policymakers face tough choices as they debate interest rates amid rising recession risks, as well as concerns about inflation and a 'bailout' of real estate speculators, analysts say.

The Federal Open Market Committee (FOMC), which meets tomorrow, is widely expected to act in the face of the worst housing slump in decades, which has led to rising mortgage defaults and a tightening of credit standards that threatens the overall economy.

A growing number of analysts said they expect the FOMC, which has held its federal funds rate at 5.25 per cent since June 2006, to cut the benchmark rate by 25 or 50 basis points.

Of key importance is the message sent to financial markets. Chairman Ben Bernanke wants to ease economic stress while averting a return to easy money conditions that, according to some critics, fuelled the real estate boom-bust cycle.

'The Fed does not want to cut the fed funds rate, but it may well be forced to because of the inevitable slowdown in US economic activity arising from the subprime-induced credit crunch,' said Sherry Cooper, chief economist at BMO Nesbitt Burns in a note to clients.

'But Ben Bernanke has made it very clear that he will not bail out imprudent lenders and investors (read hedge funds) by aggressively easing monetary policy.'

Ms Cooper said the most likely scenario is for the Fed to cut by 25 basis points and wait to see if credit conditions return to normal. She said other actions - such as injecting liquidity into markets and easing conditions for the Fed's discount window - may continue or intensify.

Joseph Balestrino, analyst at Federated Investors, agreed that the Fed is likely to use an 'incremental' approach but that more rate cuts may follow in the coming months. 'Over the near-term, as adjustable- rate mortgages reset, defaults and foreclosures are likely to rise', he said.

'This should generate still more daunting headlines, keeping markets on edge. That also should keep the Fed in the game, signalling its readiness to act as necessary to keep the economy on track. This probably means a series of additional quarter-point rate cuts.' - AFP