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The Honolulu Advertiser
Posted on: Monday, April 21, 2008

Rate cuts due for pause

By Scott Lanman
Bloomberg News Service

Hawaii news photo - The Honolulu Advertiser

Ben Bernanke

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WASHINGTON — Federal Reserve policy makers, sensing both renewed inflation dangers and a possible economic boost from government rebate checks, may be nearing a pause in interest-rate cuts after the fastest reductions in two decades.

In remarks last week, Fed Governor Kevin Warsh, San Francisco Fed President Janet Yellen and three other district-bank presidents voiced concerns about rising prices. Harvard University economist Martin Feldstein, who for almost 30 years has headed the group that decides the dates of recessions, called for an end to Fed rate cuts.

Investors are increasingly taking such talk, along with economic data and company earnings, as signs that the Fed will leave interest rates unchanged for the rest of the year after a quarter-point move on April 30. The central bank has already lowered rates three times this year, to 2.25 percent.

"We are close to the end of rate cuts," said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York. "The economy will be improving. Also, the inflation pressures are only intensifying at this point."

While Maki, a former Fed economist, is forecasting the Fed will stop for the rest of the year after a half-point reduction to 1.75 percent this month, the chance of a quarter-point move increases if financial markets improve, he said.

Chairman Ben Bernanke and the rate-setting Federal Open Market Committee next meet April 29-30 in Washington.

Stocks rallied and Treasuries dropped this week as investors reacted to earnings results that topped analysts' estimates and pared their anticipation of Fed action. The Standard & Poor's 500 Index advanced 4.3 percent, the most since February, stoked by results from companies from Citigroup Inc. to Google Inc. to Caterpillar Inc.

Two-year Treasury notes posted their biggest weekly decline since 2001, with yields climbing to 2.13 percent from 1.74 percent a week before.

The Fed has lowered the overnight lending rate between banks by 3 percentage points since September. Two points of those cumulative cuts came in the first 11 weeks of 2008, the steepest reduction since the federal funds rate became the principal tool of monetary policy around 1990.

Warsh, in a speech about financial markets on April 14, included a warning that "we also need to be alert to risks to price stability," citing higher food and fuel prices that are "putting upward pressure on core inflation and inflation expectations."

Yellen, a former Fed governor and chairman of the White House Council of Economic Advisers, told reporters April 16 that the Fed "will have to be careful not to leave monetary accommodation in place longer than it is needed."

Three other Fed bank presidents known for their more- forceful anti-inflation stances reiterated their concerns on prices.

Philadelphia Fed President Charles Plosser said the federal funds rate is already low enough to support growth, while Dallas Fed President Richard Fisher said that he's hesitant to lower rates further and warned against "inflating" the economy out of the credit crisis. Both men voted against last month's 0.75 percentage point rate cut.

Richmond Fed President Jeffrey Lacker, who dissented four times in 2006 in favor of higher rates, said April 17 that he's "uncomfortable" waiting for a contraction in the U.S. economy to bring down inflation.

'NEARING THE END'

"The Fed is nearing the end of the easing process," Pacific Investment Management Co. fund manager Paul McCulley told reporters following a speech in Charlotte, North Carolina, Friday. "I think they have signaled that."

At the same time, the Fed isn't saying that the financial- market crisis is over and that the economy is out of the woods. At a Washington press conference April 12 held in connection with the Group of Seven meetings, Vice Chairman Donald Kohn said the "turmoil has not yet settled down" and the situation is still "fragile." Bernanke and Yellen said this month the economy may shrink in the first half, though rebound in the second half.

Also, in a potential sign of renewed financial-market pressures, the three-month London Interbank Offered Rate jumped from 2.73 percent on April 16 to 2.91 Friday. The British Bankers' Association said it will speed up a review of how money-market rates are set amid concern that some contributors are providing misleading quotes.

BEAR STEARNS RESCUE

The Fed last month, in its first extension of credit to non-banks since the Great Depression, opened up lending to Wall Street securities firms at the 2.5 percent discount rate and agreed to rescue Bear Stearns Cos. from bankruptcy. The central bank also began auctioning up to $200 billion in loans of Treasury securities.

"I wouldn't rule out the idea of the Fed either increasing the size of their current operations or even switching to other possible tools to ease the situation," said Maki of Barclays. "I would be surprised if they're feeling more comfortable on the term liquidity issue at this point."

Pimco's McCulley said the Fed has "stressed that a lower fed funds rate by itself as a solo tool can't cure all that ails us."

That's an "open invitation for fiscal authorities, regulatory authorities and the private sector to pick up some of the load," he said. "It doesn't mean the Fed won't ease a lot more if it has to, but it would prefer to have some partners, if you will."