Fed cuts interest rate to 2 percent

The US central bank hints at a pause after Wednesday's quarter-point trim.

By , Staff writer of The Christian Science Monitor

After months of coordinated efforts to stimulate a faltering economy, the Federal Reserve is finally poised to sit on the sidelines for a while.

America's central bank cut its key interest rate Wednesday , bringing it down by a quarter point to 2 percent. But the big news was in the accompanying statement in which the Fed's policymaking committee sounded less anxious about economic conditions.

This doesn't mean that the risk of recession is ending. The challenges to growth – from slow job creation to defaulting mortgage loans and declining home prices – are still significant.

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Consumers also remain worried about inflation, given the reminders they see in prices at gas stations and grocery aisles.

The Federal Reserve also sees these risks. Yet policymakers appear marginally less worried than they were in March. Economists say the Fed has opened the door to a strategic pause.

"They want to wait and assess the impact of all the actions that they've taken," says Asha Bangalore, an economist at the Northern Trust Co. in Chicago. "I would say they won't do anything [on interest rates] until the end of the year."

At its scheduled policy meeting in Washington this week, the Fed announced its seventh recent move to lower interest rates for overnight bank loans. The new target of 2 percent compares with 2.25 percent in March and a recent peak of 5.25 percent last September.

In its statement, the policy committee didn't formally announce a pause. Given the current uncertainties, the Fed wants to leave various options open. But it hinted that the moves it has made this year represent a significant boost to the economy – a stimulus that is in place, though it has yet to show up in gross domestic product numbers.

Earlier on Wednesday, the Commerce Department said that GDP expanded at an annual pace of just 0.6 percent in the first three months of the year. Forecasters generally say the economy is in or near recession.

In addition to monetary stimulus from the Fed, consumers will also get a boost from an emergency fiscal stimulus fashioned by President Bush and Congress. Tax-rebate checks will add some income for millions of Americans in the coming weeks.

Meanwhile, financial markets have stabilized a bit over the past month, a welcome sign for Fed officials who have been fighting to quell panic on Wall Street.

"I think they're likely to watch and wait," Ms. Bangalore says. But how long a pause lasts "depends on the labor market and financial market conditions."

Despite worldwide concern over oil and food prices, the Fed sounded no additional alarms on inflation this week. Officials say they will "continue to monitor inflation developments carefully," but that price pressures should moderate this year.

Fed statements are often difficult to parse, since the wording often changes in subtle and gradual ways from meeting to meeting.

Peter Kretzmer, an economist at Bank of America in New York, says the Fed made two changes to the policy paragraph in its statement, to communicate its new views.

First, the policy committee removed the sentence, "However, downside risks to growth remain."

Mr. Kretzmer, in a written analysis of the Fed action, says this reflects a small reduction in uncertainty surrounding the economic outlook. Another motive, he reckons, is that "the sentence … had become a clear signal in recent months that the Fed would continue its easing."

Second, while reiterating that it "will act as needed to promote sustainable economic growth and price stability," the Fed committee removed the phrase "in a timely manner." Kretzmer says this change may convey reduced urgency.

Some economists believe that if a downward spiral in the housing market continues, the Fed could find itself under pressure to cut interest rates further at some point.

But others think the central bank is finished with its recent cycle of monetary easing.

For its part, the Fed expressed cautious hope in a carefully worded summation: "The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity."

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