USA
Fed delivers rate cut
Rob Lever
Posted Thu, 01 May 2008

The Federal Reserve delivered an expected quarter-point rate cut on Wednesday but disappointed those who had been seeking a clear signal for a pause following a series of aggressive rate moves.

The action lowered the federal funds rate to 2.0 percent, down sharply from 5.25 percent last September as the central bank offered more monetary stimulus to a sputtering US economy.

The move by the Federal Open Market Committee (FOMC) had been widely expected, but its statement highlighting concerns on both growth and inflation drew various interpretations.

Many analysts had been expecting the central bank and Chairperson Ben Bernanke to signal a halt in its rate-cutting cycle. Economist Stephen Gallagher at Societe Generale said the latest statement is "a soft, non-binding pause."

"This FOMC statement provides a soft-pause or mixed-risk view that should not be interpreted as an end to rate cuts," he said.

"Further employment weakness and the potential for another outbreak of financial market turmoil remain factors that combined could easily generate additional rate cuts."

Peter Kretzmer, economist at Bank of America, said the Fed provided "a more even-handed policy statement that provides room for the central bank to pause and allow easing to date to impact the economy."

Kretzmer said the Fed "may well pause in June and during the summer," but predicted a 1.5 percent federal funds rate later this year, assuming unemployment continues to rise.

Others said the Fed was being intentionally vague after an eight-to-two vote, with two dissenting members calling for no change in rates.

"Reading the Bible and trying to understand it"

"Understanding this statement is a lot like reading the Bible and trying to understand it," said Robert Brusca at FAO Economics. "The verbiage remains cloudy but that the Fed stands ready is clear."

Brusca said Fed rate cuts "have not succeeded in lowering the rates that are most important to consumers," such as mortgage rates.

"It looks like the Fed is acknowledging weakness, but is pointing to weakness as not as severe ... It remains concerned about inflation — how concerned? It's hard to tell."

The Fed made slight changes to its statement, prompting debate on a change in outlook. Saying for example "economic activity remains weak," instead of "weakening," might suggest some stabilization, said analysts.

"The most striking omission from the April directive was the view expressed in March that, 'downside risks to growth remain,'" said Patrick O'Hare at Briefing.com

The Fed statement also warned of growing inflation risks.

"It will be necessary to continue to monitor inflation developments carefully," the FOMC said.

"My view of the statement is that the Fed eased back on its stated concerns about the economy and slightly elevated its worries about inflation," said Joel Naroff at Naroff Economic Advisors.

That view was echoed by Eugenio Aleman, economist at Wells Fargo: "They strengthened their concern about inflation, which I thought was very wise. Everyone knows inflation expectations are going higher, and that is in my opinion the biggest risk going forward."

Aleman said the next move for the Fed is not clear from the latest statement.

"They say the economy is weak, but not weakening, so it might indicate they are done for a while" with rate cuts.

Naroff said the Fed is appropriately keeping flexible to deal with an uncertain outlook.

"By taking relatively small steps, the FOMC may disappoint those who wanted the members to signal that rate cuts were done," Naroff said. "The Committee couldn't do that. It needs the flexibility to act further if there are additional surprises or the economy doesn't come around as hoped for. Given all the challenges the economy faces, that only makes sense."

Debate is still raging on the outlook

But debate is still raging on the outlook. The latest data shows an economy that is struggling but still growing.

The Commerce Department reported on Wednesday gross domestic product expanded at a 0.6 percent annual pace in the first quarter, slightly better than expected.

Andrew Busch at BMO Capital Markets said the Fed missed an opportunity to strike a blow against inflation and commodity speculation by holding rates steady.

"The Fed's actions are disappointing from the standpoint of the dollar and for dampening commodity prices," said Andrew Busch at BMO Capital Markets.

"The Fed is clearly still willing to risk inflation over growth at this point. I think this is a mistake as holding off from cutting would've given them room to cut later should they need it and would've cooled some commodity inflation."

AFP