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Sluggish US economy to do without rate cuts

Latest update : 2008-05-22

Minutes released from a Federal Reserve meeting suggest the US central bank will not make any further rate cuts, though forecasts for growth this year were again revised downwards to a range of 0.3 to 1.2 per cent.

The Federal Reserve sent out signals Wednesday the US economy will have to muddle through its crisis without further rate cuts, even as the central bank slashed its forecast for growth in 2008.

 

In minutes released from its April 29-30 policy meeting, the Fed said its decision to cut rates by a quarter point was "a close call" and that the "substantial easing" since last September plus other measures would help underpin economic activity.

At that meeting, the Federal Open Market Committee (FOMC) led by chairman Ben Bernanke voted 8-2 to cut the federal funds base lending rate by a quarter point to 2.0 percent, the latest in a series of rate cuts since September aimed at firing up lagging growth.

But the panel stated that "it was no longer appropriate for the statement to emphasize the downside risks to growth," according to the minutes.

The minutes also said that "several members noted that it was unlikely to be appropriate to ease policy ... unless economic and financial developments indicated a significant weakening of the economic outlook."

"The prevailing message of the minutes for the stock market is that we have very likely seen the end of this rate-cutting cycle," said Patrick O'Hare at Briefing.com.

"You can never say never, but that thinking helps explain why there was a sharp move lower (in the stock market) immediately following their release."

Wall Street's main indexes tumbled more than 1.6 percent. Losses accelerated after the Fed release, which came along with an updated economic outlook in which the central bank also made a sharp downward revision for growth to a range of 0.3 to 1.2 percent, from its prior forecast of 1.3 to 2.0 percent.

The new outlook, part of the Fed's new policy for more frequent updates, was roughly in line with many private economist forecasts for sluggish growth which would put the world's biggest economy on the brink of recession.

The US economy expanded at a tepid 0.6 percent pace in the past two quarters, with some analysts expecting a recession from the horrific slump in housing and related credit squeeze.

"Participants viewed activity as likely to be particularly weak in the first half of 2008; some rebound was anticipated in the second half of the year," the Fed statement said.

Still, the Fed appeared to be saying markets can no longer expect rate cuts to prop up flagging growth.

Fed governor Kevin Warsh made the point more emphatically in a Washington speech as the minutes were released.

"The Federal Reserve has employed the hammer with considerable force in the last nine months, lowering the federal funds rate by 3.25 percentage points, with wide-ranging implications for the economy," Warsh said.

"But now, policymakers may be well-served encouraging a new financial architecture to emerge, aided, in part, by the actions we have taken. Even if the economy were to weaken somewhat further, we should be inclined to resist expected, reflexive calls to trot out the hammer again."

Warsh also appeared to suggest the Fed cannot cure all the ills of the banking system, which has tightened credit, with a potential to crimp economic growth.

He said Fed rate policy "is imperfectly suited to compensate for declines in liquidity arising from retrenchment in the financial sector for long periods."

Brian Bethune, economist at Global Insight, said he believes the Fed has not closed the door to rate cuts, but will not act soon.

"While this suggests that the Fed is on hold for several months, the key issue that will emerge by September is the outlook for growth 2009," Bethun said.

Bethune said the "props" from the government's 168-billion-dollar economic stimulus and tax rebate program will be "pulled out from under the economy" later this year, which could force the Fed to rethink the question of rate cuts.

"From our vantage point it looks very likely like the FOMC will have to lower its (economic) forecast band for 2009 when these forecasts are updated for the September and December meetings of the FOMC," he said.

"In view of these late-2008 expected downward revisions to the Fed's central tendency forecast for 2009, Global Insight believes that there is a strong likelihood that the Fed will move to lower rates by about 50 basis points in the final months of 2008."
 

Date created : 2008-05-22

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