Fed officials hint at potential for still lower interest rates

By Ros Krasny
Reuters
via Yahoo News
Wednesday, November 7, 2007

http://news.yahoo.com/s/nm/20071107/bs_nm/usa_fed_dc;_ylt=AijlHAlq905n9G...

MILWAUKEE, Wisconsin -- Federal Reserve officials on Wednesday said more interest rate cuts could be needed if economic growth proves weaker than expected, just a week after hinting that rates would probably stay steady for now.

Uncertainty about how events will play out in the housing and financial markets make another rate cut more likely than a rate hike, William Poole, a voting member of the policy-setting Federal Open Market Committee in 2007, told reporters after a speech at Marquette University.

"It could be that the downdraft from the housing industry will spread to other sectors, which might require that recent rate cuts not be reversed, or even that additional cuts would be in order," he said.

The U.S. central bank has cut benchmark interest rates twice, by a total of three-quarters of a percentage point, over the past two months, bringing the federal funds rate at 4.50 percent from 5.25 percent.

In announcing its second cut on October 31, it said risks to growth and the risk of inflation were about evenly balanced, implying a reluctance to lower borrowing costs further.

Even so, financial markets lean heavily toward another one-quarter-point rate cut on December 11, the final FOMC meeting of the year. The implied prospects for a move jumped on Wednesday to 76 percent from 62 percent.

"While the concern over increasing inflation pressures continued to be prevalent, Fed speakers continue to note the downside risks from the housing and credit markets. This, in our view, leaves the door open to further rate cuts," Merrill Lynch economist David Rosenberg said in a research note.

The Fed, along with most other forecasters, anticipates a marked deceleration in growth in the fourth quarter after a surprisingly brisk outcome reported for the third quarter.

Fed Chairman Ben Bernanke is expected to expand on the Fed's outlook for the economy in testimony before Congress on Thursday.

With fourth-quarter economic softness on the radar, it will take an even weaker-than-expected result for the Fed to consider moving rates again, Poole said. A key risk is that falling home prices could cause consumption, the largest component of U.S. gross domestic product, to grow "significantly slower," he added.

Meanwhile, Atlanta Fed President Dennis Lockhart said the outlook for a return to near-trend economic growth by late in 2008 situation remains uncertain given evidence of business spending retrenchment.

Despite recent signs of a resilient economy in the form of strong employment and personal spending, there is evidence of a business spending retrenchment, Lockhart said in a speech to the Huntsville, Alabama, Rotary Club.

"Recent feedback from our Reserve Bank board members and other contacts on the ground is somewhat more negative than the numbers suggest," he said.

However, in an interview published on The New York Times's Web site late on Tuesday, Philadelphia Fed President Charles Plosser said it would take a "drastic" fall in growth for him to support another rate cut.

Plosser, a well-known policy hawk, will get his first vote on the FOMC in 2008 since joining the Philly Fed in 2006.

The inclusion of that balance of risks assessment in the Fed's October 31 statement was not accidental, but rather a step toward the return to a more normal policy-making approach after the disruptive events of August and September, Poole noted.

On a day when crude oil prices approached $100 a barrel, gold prices spiked and the dollar sank to record lows, policy-makers also confronted the potential for inflation and inflation expectations to rise, only months after inflation seemed to have been brought under control.

"There are also important reasons to be concerned about the outlook for inflation," Fed Governor Kevin Warsh told the New York Association for Business Economics.

Poole looked for the Fed to strike just the right balance on policy to boost market confidence, doing "what is necessary, but not more" on interest rates.

"Excessive rate reductions would run the risk of increasing inflation in the future" and of setting up an "unpleasant environment" of rising inflation fears and higher long-term interest rates, he said.

Still, Fed Governor Frederic Miskin said it was important not to "overreact" to rising oil prices and take a longer-term view on their effect on inflation as the economy slows.

"We find that the impact of the dollar depreciation on the overall price level is actually quite limited," Mishkin said while testifying before the U.S. House of Representatives Small Business Committee.

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