Are Fed rate cuts nearly over?

After a potential cut Wednesday, the central bank may pause to assess the economy.

By , Staff writer of The Christian Science Monitor

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    His stand: A protester outside Bear Stearns's headquarters in New York last Friday criticized Fed Chairman Bernanke's economic policies. The Fed will review interest-rate levels this week.
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In the past eight months, the Federal Reserve has embarked on the most aggressive interest-rate reductions since 1982, when America's central bank decided it needed to jolt the economy out of a recession with a massive infusion of money.

On Wednesday, the Fed is expected to make one more quarter-point drop. But economists anticipate that the central bank, which is chaired by Ben Bernanke, will then pause and reassess the economy. Wall Street will be particularly anxious to see how the Fed explains its actions: whether the pause is because the central bank sees an economy on the mend or because its focus is shifting to inflation concerns.

If interest rates do stop falling, it could give some support to the battered US dollar, economists say. A stronger dollar might discourage some speculative money from being invested in oil and other commodities.

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The Fed's actions could also send an important psychological signal, economists say. "A pause by the Fed is a reflection of the fact the Fed thinks the worst is over or at least the bottom is in sight for the economy," says David Wyss, chief economist for Standard & Poor's in New York.

Just before making its decision Wednesday, the Fed will get a chance to view the Commerce Department's initial report on gross domestic product (GDP) for the first quarter. Only a month ago, many economists had expected it would show negative growth. But now the expectation is for a small amount of growth.

Instead, economists expect the negative period of economic growth will be from April to June. Some estimates call for a drop of between 2 and 3 percent, which would be the steepest contraction since the end of 1990.

"And, contrary to popular opinion, the income data are, on net, getting worse, not better," writes David Rosenberg, chief economist at Merrill Lynch & Co. in New York, in an e-mail to clients.

His bearish view of the economy is not shared by everyone, however. "We may not turn out to have a serious recession," says Lyle Gramley, a consulting economist with the Stanford Group in Washington and a former Fed governor. "It may turn out to be an extended period of modest growth."

Credit availability

Even if the Fed stops lowering interest rates, some economists believe the central bankers will still have to continue addressing the availability of credit. "The Fed is not getting traction with these aggressive rate reductions because of the credit crunch," Mr. Gramley says. "We're not getting the bang for the buck we usually get."

However, banks have been raising capital, he notes. "It suggests the banks are starting to heal a little bit," he says.

The Fed may talk about the credit problem in the statement that it issues once it announces its decision on rates, says Doug Roberts, a monetary expert at Channel Capital Research Institute in Shrewsbury, N.J. In recent weeks, the Fed has been active in providing the banking system with liquidity. "There is not a pause in the credit crisis," he says.

If the Fed does stop lowering interest rates, Mr. Roberts expects to see some temporary strengthening of the US dollar. The dollar, he adds, may also get some help from the European Central Bank, which may also lower interest rates. One reason: German consumer confidence is down, he says.

Mr. Wyss thinks the Fed may have some room to pause since the rebate checks, part of the government's $152 billion stimulus package, will have started going out on Monday. Some 130 million Americans will receive the payments: $600 per person, $1,200 per couple, and an additional $300 per child.

"The Fed will want to see if Americans spend the money before they decide if the economy needs an extra boost," Wyss says. "There is enough going out for a quarter [three months] of growth."

Inflation watch

Analysts will be watching closely for any signs that the Fed is becoming alarmed about inflation. Last month, the Labor Department reported that consumer prices grew by 4 percent compared with a year ago. "We're starting to see increases," says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. "If you drive a lot, eat dairy products, and send your kids to college, it will be a lot higher."

Even more worrying for the Fed are surveys that find Americans are starting to expect higher prices. One such survey is from Reuters and the University of Michigan. "But so far, it's more in the short run than the long run," Mr. Brown says.

Even though the Fed is expected to lower rates again, the effect on consumers' pocketbooks may be modest. For example, variable-rate credit cards could see rates drop by a quarter of a percentage point. But on a $5,000 balance, that would save $1 a month, estimates Bill Hardekopf, CEO of LowCards.com, a consumer website.

"It's not going to send you on your way to buying a new car," he says, "but every bit helps."

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