FOMC Statement Shows Policy, Economy In Flux

September 19, 2007

CHICAGO - THE US Federal Reserve's policy-setting panel on Tuesday issued a statement that discarded its familiar balance of risks assessment and allowed it greater flexibility during a time of maximum uncertainty.

For the first time in several years, the central bank's Federal Open Market Committee downplayed risks to inflation and focused on obstacles to growth that have grown out of recent disruptions in financial markets.

But the central bank, in announcing a half-percentage point cut in benchmark overnight interest rates, did not indicate whether its 'predominant concern' was the potential for faltering growth or inflation, an absence Fed watchers said reflected the shifting sands of the global credit crisis.

'The Fed isn't sure which risk is greater, so it is preserving its options,' said Tom Gallagher, head of policy research at investment advisory and trading firm ISI Group in Washington.

'We would guess the Fed's presumption is no rate cut in October, unless subsequent data or market developments suggest a deterioration in the outlook.' The FOMC said 'some inflation risks remain,' in contrast with the view it expressed after its last regularly scheduled session on Aug 7, when it said the risk that inflation would fail to moderate was its 'predominant policy concern.' 'The Fed finally recognises what most of Wall Street has known for some time, that there is a greater risk of weakness in the economy than inflation,' said Alan Skrainka, chief market strategist at Edward Jones in St Louis.

Tuesday's statement was the Fed's first full-on response to the global credit crisis that erupted only a few days after officials gathered on Aug 7.

Policy-makers had already signalled a willingness to consider rate cuts in a terse statement issued on Aug 17 that said downside risks to growth had increased 'appreciably.' That statement was issued in conjunction with an announcement by the Fed's Washington-based board that it had approved a cut to the discount rate the central bank charges on loans to banks.

The central bank hammered the same theme on Tuesday.

'The tightening of credit conditions has the potential to intensify the housing correction and forestall economic growth more generally,' it said, echoing comments last week by San Francisco Federal Reserve Bank President Janet Yellen.

Analysts said the more dovish wing of the central bank had apparently won this round of the policy debate, to the dismay of inflation hawks who immediately pushed up yields on longer-dated US Treasury debt.

After the somewhat surprising half-point cut that took the federal funds rate to 4.75 per cent, the yield on the 30-year Treasury bond jumped to 4.77 per cent from 4.68 per cent.

Fed Chairman Ben Bernanke 'is following his own teachings on 'financial accelerators' that suggest that when there are severe financial problems, it is important that the central bank step ahead of the curve,' said Alan Ruskin, chief international strategist with RBS Greenwich Capital in Greenwich, Connecticut.

'He will likely have had support from (Fed Governor Frederic) Mishkin and Yellen, and they appear to have won the day with more conservative governors and staffers.' Economist Allan Meltzer, a professor of political economy at Carnegie Mellon University in Pittsburgh, said the Fed had made 'a big mistake' in slashing rates while inflation risks still abound and the jobless rate is a mere 4.6 per cent.

Prof Meltzer, author of 'A History of the Federal Reserve,' dismissed any deep meaning to the FOMC statement. 'The words don't mean a damn thing - look at the action,' he said. -- REUTERS