April 18, 2008 / 12:50 AM / 11 years ago

Fed officials cool on need for rate cuts

PHILADELPHIA (Reuters) - Federal Reserve officials continued to hint on Friday that they are reluctant to cut interest rate further as the sluggish U.S. economy also faces a threat from inflation.

The Federal Reserve Building is pictured in Washington, March 18, 2008. REUTERS/Jason Reed

Charles Plosser, President of the Philadelphia Fed, warned against seeing rate cuts as “the solution to most, if not all, economic ills.”

Plosser was the latest in a string of policy-makers to warn about the risk of inflation, suggesting another rate cut could be a tough sell.

Real interest rates are now at “an accommodative level,” and low enough to boost growth back toward its long-term trend over time, Plosser said in a speech at Drexel University’s LeBow College of Business in Philadelphia.

Plosser, one of the Fed’s biggest anti-inflation hawks, voted against the Federal Open Market Committee’s 75 basis point interest rate cut in March, banding together with Dallas Fed President Richard Fisher.

On Friday, Plosser said the Fed has been acting on several fronts to address the upheaval in financial markets but that ultimately “the markets will have to solve these problems, as indeed they will.”

Meanwhile, Eric Rosengren, president of the Boston Fed, said that banks must raise capital to shield themselves from future losses.

It would be better to cut dividends to achieve this than to rein in lending, Rosengren told a credit market symposium in Charlotte, North Carolina, hosted by the Richmond Fed.

Rosengren and Plosser agreed that further financial market turmoil had the potential to crimp the overall U.S. economy by restricting credit for many Americans.

That threat is foremost in policy-makers’ minds as they weigh their options, said Rosengren, who is not an FOMC voter in 2008.

“The availability of credit can become a factor for some subsets of borrowers,” he said.

Plosser said the tightening of credit “has the potential to continue to restrain economic growth going forward,” but he said he remained cautiously upbeat.

“Monetary policy works with a lag ... the full impact of changes in monetary policy on output and employment may not materialize for several quarters at the earliest,” he said.

The FOMC next meets to consider interest rates on April 29-30.

A barrage of Fed speakers this week has undermined the market’s expectations for another big cut to the federal funds rate.

On Thursday, Fisher restated his “strong reluctance” to lowering rates any further.

Even Janet Yellen, one of the Fed’s policy-makers who is more concerned with boosting growth, said this week that “inflation is a problem” and that the Fed must be careful not to cut rates more than needed.

Traders of futures contracts that reflect market sentiment on Fed policy are increasingly less certain the Fed will lower rates this month from the current 2.25 percent. A few days ago, dealers saw a strong chance for a 50 basis point cut.

Plosser said it was a “dangerous misconception” to think that monetary policy can be a cure-all for the problems in the U.S. economy and financial system.

“The role of monetary policy is to ensure the stability of the purchasing power of the nation’s currency, so that markets are not distorted by inflation,” he said. “We should never ask monetary policy to do more than it can do.”

While some economists and Fed officials may think that slower growth will pull elevated levels of inflation back into line, Plosser was skeptical.

“A slowing economy is no guarantee of slowing inflation,” he said, noting that the “broader base” of price rises, from health care to crude oil, suggested underlying pressure.

Additional reporting by Alister Bull in Charlotte; Writing by Ros Krasny; Editing by Tom Hals

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