Fed Cuts and Signals Halt

The Washington Post

Quarter-Point Slice off Funds Rate May End Booster Shots

The Federal Reserve cut a key interest rate yesterday by a quarter of a percentage point, its latest step to try to bolster the ailing U.S. economy. But the modest cut came with a strong signal that the Fed’s seven-month rate-cutting campaign is probably over for now.

On the same day that a new report indicated the economy grew at a meager but better-than-expected 0.6 percent annual rate in the first quarter, the Fed made clear that it was entering a new stage of assessing how much its aggressive actions — this is the seventh rate cut since September — combined with fiscal stimulus checks being mailed this month would help the economy.

Yesterday’s action lowered the federal funds rate, at which banks lend to each other, to 2 percent. That is likely to eventually lead to lower borrowing costs for someone taking out an adjustable-rate mortgage or using a credit card, or for a business seeking money to expand. The goal is to prevent the economic downturn from becoming severe and prolonged.

“This move is buying insurance against a deeper recession,” said Arun Raha, senior economist at Swiss Re.

In a statement accompanying the action, the Fed conveyed, in the ever-so-subtle language of central banking, that it was not planning more rate cuts. The statement omitted a sentence from the Fed’s last communication on March 18 that “downside risks to growth remain.” The Fed said yesterday that it would “act as needed” to promote growth, whereas the phrasing in March was “act in a timely manner as needed.” And yesterday’s statement said that the “substantial” rate cuts to date should help promote moderate growth over time, wording that carried an air of summing up past Fed actions.

As Fed-watchers parsed every comma of the statement, the message came through loud and clear.

“They’re saying, ‘Look, we’ve had monetary policy on steroids for the last few months, but that is changing now,’ ” said Christian Menegatti, an analyst at RGE Monitor.

But by phrasing its inclination to pause with such restraint, the Fed was trying to remain flexible. If the economy were to deteriorate even more than is now forecast, or the crisis in financial markets deepens, the interest rate cuts would almost certainly resume.

That could help avoid past communications missteps, notably in October, when the central bank cut rates but said that the risks of inflation and growth were “roughly balanced,” a fairly explicit statement that it was done cutting rates. When the financial markets entered a period of renewed crisis in the ensuing weeks, there was confusion in the markets about whether the Fed would respond aggressively.

“This doesn’t guarantee anything to anyone,” said Drew Matus, a senior economist at Lehman Brothers, referring to the statement yesterday. “They did keep their options open.”

Leaders of the Fed are worried that high inflation, driven by higher prices for food and energy, will significantly raise Americans’ expectations of future inflation, which can be self-fulfilling. Continued rate cuts could cause the value of the dollar to fall further, worsening a source of inflation.

“Energy and other commodity prices have increased,” said the statement from the Federal Open Market Committee, the Fed’s policymaking arm, “and some indicators of inflation expectations have risen in recent months.”

Those are major reasons to avoid cutting rates any further; continued lowering of rates could undermine the central bank’s credibility as an inflation-fighter.

Some policymakers didn’t want to go this far. Dallas Fed President Richard W. Fisher and Philadelphia Fed President Charles I. Plosser dissented from the rate cut.

Both have expressed more hawkish views about inflation than have other Fed leaders. There has been at least one dissenter at every meeting of the policymaking committee since September, reflecting both the uncertainty surrounding the economic outlook and the fact that Fed Chairman Ben S. Bernanke has a more democratic style than his predecessor, Alan Greenspan.

The Fed had room to maneuver in part because the economy, while weak, hasn’t softened any more than analysts have been expecting. That is underscored by yesterday’s report on gross domestic product, the broadest measure of economic output.

The nation’s output rose at an 0.6 percent annual rate in the first three months of the year, the Commerce Department reported, the same pace as in the fourth quarter of last year. Economists had expected slower growth.

There was little good news in the details of the report, however. Much of the growth came from a buildup in business inventories, which resulted from weak demand for products. Businesses are likely to deplete those inventories in the months ahead, creating a new drag.

And investment in housing fell 26.7 percent, the steepest decline in a single quarter on record.

The new data lower the likelihood that the nation will turn out to be experiencing a recession, which is formally defined as a significant decline in economic activity lasting more than a few months. However, many other data suggest that the economy is contracting, and the GDP data will be revised as more information becomes available.

President Bush had been criticized by Democrats for repeatedly declining to declare that the nation had entered a recession. Statements from the White House held a whiff of vindication yesterday.

“This represents a small but positive growth in the United States economy, and it is about what you have heard us say we were expecting in this quarter,” said press secretary Dana Perino. But, she added later, “make no mistake, while this was slow growth, the president doesn’t believe it’s anything to crow about.”

The stock market was up substantially on the positive news about GDP, with the Dow Jones industrial average ahead more than 120 points at one point. It then fell shortly after the Fed announcement, as traders were displeased to realize that Fed rate cuts may no longer be in the offing, and major indicators ended the day down slightly.