Modest U.S. growth, CPI to trigger late 2007 rate cut

By Burton Frierson

NEW YORK (Reuters) - A cooling housing sector will modestly slow the U.S. economy and tamer inflation should allow the Federal Reserve to cut interest rates just once this year, but only in the fourth quarter, a Reuters poll showed.

But that rate forecast is a close call and marks a dramatic change from a survey taken just one month ago which showed economists forecasting rates falling 25 basis points to 5.0 percent by end-June and then again to 4.75 percent in the fourth quarter.

The poll of 89 economists expects the world's largest economy to record gross domestic product growth of 2.7 percent overall in 2007, down from an expected 3.4 percent in 2006 but above the 2.5 percent they were predicting in January.

After months of taking a more bearish view, analysts' predictions are now in line with the Federal Reserve's own recently updated forecasts, which predict GDP growing 2.5-3.0 percent in 2007.

Along with a deceleration in inflation the Fed would like to see slower employment growth to help ease broader price pressures before it lowers borrowing costs, said Avery Shenfeld, senior economist at CIBC World Markets in Toronto.

"We have the middle two quarters being relatively sluggish and then (economic) growth picking up after the Fed cuts rates in the later part of the year," he said.

The poll forecast economic growth averaging an annualized 2.5 percent in the first quarter, edging up to 2.6 percent in the second quarter and 2.9 percent in both the third and fourth quarters and then up to 3.0 percent on average in 2008.

That comes despite the re-emergence of a softer tone in economic data over the past week, following a spate of firm data releases for January amid unseasonably warm weather. But the survey also reflects concerns that it will take time to tamp down inflation.

Minutes to the Fed's January policy meeting on Wednesday, released after the poll was conducted, suggest that the Fed shares those concerns.

INFLATION WATCH

Though the expected modest economic slowdown should bring down price pressures a tight labor market will make progress slow, meaning the Fed is likely to cut rates by just a quarter point this year and only in the final three months of 2007.

But while 41 economists see at least one Fed cut before year-end a significant minority -- 37 of 78 -- say the Fed will keep rates on hold or move them higher. Eleven predict rates at 5.5 percent or higher by the end of the fourth quarter.

Data on Wednesday, after the poll was conducted, underlined the possibility that taming inflation could take longer than expected as consumer prices rose more than expected in January despite a dip in energy costs.

The data showed a surprise 0.3 percent rise in consumer prices excluding food and energy, driven mainly by a spike in medical costs.

"Slower growth and decelerating inflation will allow the Fed to adjust policy by the end of second quarter 2007 but persistent higher inflation than expected could result in the Fed remaining on hold for a prolonged period," said Aurore Wannesson-Raynaud, strategist at AXA IM in Paris.

Overall, economists projected consumer price inflation would run at 1.9 percent this year, down slightly from last month's poll, which projected it at 2.0 percent.

The latest survey put inflation at 2.0 percent in the first quarter, dipping to 1.5 percent in the second, 1.4 percent in the third and bouncing back to 2.4 percent in the fourth.

On a core basis, which strips out volatile food and energy, the poll projected price growth at 2.3 percent in 2007, the same prediction analysts made last month.

The survey put core inflation at 2.5 percent in the first quarter, declining to 2.3 percent in the second, 2.1 percent in the third and edging back up to 2.3 percent in the fourth. Core CPI inflation should average 2.2 percent in 2008.

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