Fed's adjusted wording flags pause in rate cuts

By Alister Bull - Analysis

WASHINGTON (Reuters) - The Federal Reserve on Wednesday took a page out of its 2003 playbook by tweaking the language of a policy statement to communicate a conditional halt in its campaign of interest rate cuts.

After a two-day meeting, policy-makers lowered the overnight benchmark rate by 25 basis points to 2 percent, as expected. At the same time, they emphasized the size of the total, 3.25-percentage-point reduction in the rate since September, while acknowledging the economy remains fragile.

Moreover, the Fed's statement dropped a clear signal to definitely expect further rate cuts by omitting the phrase "downside risks to growth remain." The phrase was featured in its statements on March 18 and January 30, when the Fed lowered rates by a cumulative 125 basis points.

That language tempered the more assertive wording of its statement on January 22, when an emergency cut of 75 basis points was made and the Fed warned that "appreciable downside risks to growth remain."

On Wednesday, the central bank also reshaped the final sentence of the main body of its policy statement to restore the phrase "will act as needed." That compares with the slightly more directed "will act in a timely manner," employed since January.

The Fed introduced the earlier wording to warn markets it could move between meetings to shield the economy from the chilling impact of the housing crisis, as it did on January 22.

"The Fed has shut the door on additional rate cuts, but the door remains unlocked in the event that additional financial market and credit-related events surface," said Richard Yamarone at Argus Research Corp.

Interest rate futures imply the Fed staying at 2 percent until the latter part of the year, with a modest, 24 percent likelihood, priced in to markets that it will trim another quarter percentage point at its meeting in late June.

In June 2003, when the Fed rested after a long rate-cutting campaign to 1 percent, it also jettisoned specific wording that pointed to more action.

Back then, the Fed substituted the phrase, "taken together, the balance of risks to achieving its goal is weighted toward weakness in the foreseeable future," from the previous meeting on May 6, and instead talked up the risks of inflation.

This time around the Fed also expanded its discussion of inflation, noting that while core inflation has moderated somewhat, "energy and other commodity prices have increased, and some indicators of inflation expectations have risen."

It used the word "inflation" five times, the same number as its March 18 policy statement. But this time the Fed warned that "uncertainty about the inflation outlook remains high."

That was a slightly more adamant construction than the wording in March that warned "uncertainty about the inflation outlook has increased."

"In a silent, but very lucid manner the Fed chief and the committee have clearly acknowledged the very real issues with inflation expectations that have developed," said Joseph Brusuelas, U.S. chief economist at IDEAglobal in New York.

"The risks to the upside vis-a-vis inflation are serious enough to be on hold until the lagged impact of past Fed monetary policy and the fiscal stimulus on its way take hold," he said.

(Reporting by Alister Bull; Editing by Frank McGurty)