Fed Easing Up On Rate Cuts Despite Slowing Economy

Source : The Business Times, April 10, 2008

Members say cuts alone won’t solve problems; express concern over prices

(WASHINGTON) Federal Reserve officials signalled that they would slow the pace of interest-rate cuts even as they concluded that ’some contraction in economic activity’ is likely.

Some Federal Open Market Committee members saw the danger of a ‘prolonged and severe downturn’, according to minutes of its March 18 meeting released yesterday. Still, ‘monetary policy alone could not address fully the underlying problems in the housing and financial markets’, the minutes said.

Policy makers cut the benchmark lending rate by 2 percentage points in the first 11 weeks of the year, the fastest pace in two decades. They may now need to assess the impact of the reductions, US$168 billion of fiscal stimulus, and several steps to increase liquidity in financial markets.

The Fed’s target rate for overnight loans between banks is 2.25 per cent, down from 5.25 per cent in September. Economists anticipate officials will stop lowering borrowing costs after cutting the rate to 1.75 per cent in June, according to the median of 62 estimates.

‘The most important factor is, I think, that they know that the fiscal stimulus is about to go out,’ said Jan Hatzius, chief US economist at Goldman Sachs Group in New York, referring to tax rebate checks scheduled for distribution from May. Fed policy makers ‘are very reluctant to go below 1 per cent. And they’re pretty reluctant to go below 2.’

Fed Chairman Ben Bernanke has overseen an expansion of the Fed’s efforts to alleviate the credit crunch that has gone beyond rate cuts, including making loans directly to investment banks.

The central bank also made an emergency loan to Bear Stearns Cos and agreed to take on US$30 billion of the firm’s assets to secure its takeover by JPMorgan Chase & Co. Yesterday’s minutes included no details on the discussions surrounding the decision, which was made by the Fed’s Board of Governors, rather than the FOMC.

Fed staff economists told policy makers that they had ’substantially revised down’ their forecast to show a first-half contraction in gross domestic product, with a ’slow rise’ in the second half. In 2009, the staff projected growth ’somewhat above’ the economy’s long-term potential pace, the minutes showed.

Some stabilisation in US housing markets is probably needed to ‘underpin’ the economy’s recovery, though policy makers saw ‘little indication’ that the process had begun, the minutes said.

Policy makers continued to express concern about rising consumer prices, although ‘most participants still expected inflation to moderate later this year and in 2009′, the minutes said. Fed staff economists also projected that inflation would slow next year.

The Fed’s preferred inflation measure, the personal consumption expenditures price index minus food and energy, rose 2 per cent in February from 12 months before. Including the two items, prices climbed 3.4 per cent, the fourth straight month in excess of 3 per cent.

Committee members last month also discussed evidence of an ‘adverse feedback loop’, where lenders reduce credit, hurting growth and causing lending to contract further, the minutes showed. — Bloomberg