Fed lowers rates, hints cuts may be at end

WASHINGTON (Reuters) - The Federal Reserve lowered interest rates by a modest quarter percentage point on Wednesday, as expected, and hinted the move could be the last in a series meant to buffer the economy from a credit crunch and housing downturn.

The Fed, however, kept its options open and nodded to ongoing financial market stress, tight credit and the deepening housing contraction, leaving some market participants guessing rates could still move lower.

The central bank’s action takes the bellwether federal funds rate target, which banks charge each other for overnight loans, to 2 percent -- the lowest since December 2004. It was the seventh cut in a campaign that has brought the key lending rate down by 3.25 percentage points since mid-September.

The Fed also on Wednesday cut the discount rate it charges on direct loans to banks by a matching quarter point.

“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,” the central bank said.

Two officials -- Dallas Federal Reserve Bank President Richard Fisher and Philadelphia Fed chief Charles Plosser -- dissented from the decision, preferring to hold rates steady.

In addition to citing the “substantial” rate reductions now in place, the Fed took note of rising prices for energy and other commodities and dropped a phrase contained in its last announcement that “downside risks to growth remain.”

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It also shifted away from a promise to “act in a timely manner” to a softer commitment to “act as needed.”


Taken together, analysts said the changes suggested policy-makers were now willing to sit back to see if the economy, which some think may be in recession, picks up speed.

The Fed is “basically telling you that unless their outlook for the real economy deteriorates further, they will stay at 2 percent,” Mohamed El-Erian, co-chief executive officer of Pacific Investment Management Co (PIMCO), told Reuters.

On Wall Street, U.S. stock indexes closed slightly lower, while prices for government bonds rose. The dollar weakened against the euro, but traded flat against the yen.

A Reuters poll of 19 top bond firms that deal directly with the Fed in the markets found them split on the question of whether the Fed had now done enough to support the economy.

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Ten of the so-called primary dealers said the Fed was not done yet, with eight saying it was. One of the dealers surveyed did not offer an opinion.

The median forecast, however, pointed to a further quarter-point cut in the fed funds rate by year-end.

President George W. Bush on Tuesday said the U.S. economy faced a “tough time,” a point underscored on Wednesday by a report that showed U.S. gross domestic product expanded at a slim 0.6 percent annual rate in the first quarter.

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While the modest rate of growth was slightly stronger than economists had expected, it reflected a buildup in inventories that may weigh on the economy in the coming months.

Other details in the report were decidedly weak.

Consumer spending, which accounts for two-thirds of U.S. output, grew at the slowest pace since 2001, business investment fell and home building continued to nosedive, recording the biggest drop in 26 years.

At the same time, with U.S. gasoline prices heading toward $4 a gallon and strong global demand pushing up food prices, some Fed officials have worried openly that a desire to bolster the economy could divert the central bank’s attention from inflation pressures.


The Fed said there was some evidence core inflation, which strips out volatile food and energy costs, was easing and it still believed inflation would moderate over time.

But it also said uncertainty about the inflation outlook remained high, noting the rise in energy and other commodity prices and some signs inflation expectations had moved up.

“This statement strongly implies that the Fed will be on pause for some time,” said Joseph Brusuelas, U.S. chief economist at research firm 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. As part of an economic stimulus plan, tax rebates began flowing to U.S. households this week.

Even though the Fed dropped language about downside risks to growth, it said economic activity was weak, with business spending subdued and labor markets softening.

Additional reporting by David Lawder and Alister Bull in Washington and Jennifer Ablan in New York; Editing by Neil Stempleman, Gary Crosse