Fed likely to cut US rates, could signal pause


The US Federal Reserve is expected to put an exclamation point on its string of interest- rate cuts with a small reduction this week and may signal that its rate-cutting cycle is done for now.

Rising global inflation and the Fed's hope that a blend of monetary and fiscal stimulus will shore up the anemic US economy suggest the central bank is ready to pause in the sharp easing cycle it kicked off in mid-September.

Fed Chairman Ben Bernanke and his colleagues have lowered benchmark overnight lending rates 3 full percentage points to 2.25% over that span.

Policy-makers meeting on Tuesday and Wednesday look set to lower them by a slim quarter point and then step aside to see whether their handiwork has the desired effect in spurring an economy socked by a housing slump and credit market disarray.

While officials still worry about downside risks for the economy, which they think may be facing recession, they also are concerned forecasts for an ebbing in inflation may prove off track. Soaring prices for oil and food have fed a global inflationary surge, sparking food riots in some countries.

“The Fed's intention to pause its easing cycle may be part of an international effort to stabilize the falling value of the dollar, in light of the deteriorating state of world food prices,” said Ashraf Laidi, chief foreign exchange strategist at CMC Markets US in New York.

A Reuters survey on Friday of the 20 big bond firms that deal directly with the Fed in the markets found that all of them expect a quarter-point rate cut this week.

Interest-rate futures markets are less certain. Late on Friday, rate futures showed a 76% chance of a cut, but an almost one-in-four chance the Fed would hold steady. They also suggest rates will end the year back at 2.25%.

The FOMC slashed rates by three-quarters of a point in March, but drew two dissents by officials concerned lower rates could exacerbate price pressures. Wednesday's announcement will be pored over for hints the Fed now intends to pause.

The statement should have “somewhat stronger language justifying concerns over inflationary pressures, inflationary expectations, and soaring food and energy prices,” said Dan North, chief economist at Euler Hermes in Owings Mills, Maryland.

Several Fed officials across the dove-hawk spectrum have already sharpened their rhetoric on inflation, while expressing guarded confidence the economy will have turned for the better by the second half of the year.

“Monetary policy decisions depend critically on the outlook for the economy over the medium term,” Philadelphia Federal Reserve Bank President Charles Plosser said on April 18.

Plosser and Dallas Fed President Richard Fisher voted against the Fed's big rate cut on March 18, preferring less aggressive action. Fisher has emerged as the FOMC's anti-inflation ringleader, with two dissents this year.

He has urged the Fed to lean less on rate cuts and more on measures to provide liquidity to clogged financial markets as a way of easing the credit crisis without stoking inflation.

“It's really a question of, are we getting the bang for the buck (from interest rate cuts). And clearly we're not,” Fisher said on Tuesday.

Indeed, some economists argue low rates have encouraged investors to bid up prices for oil and other commodities. Crude oil prices are up about 24% so far this year and the Reuters-Jefferies CRB index of commodity prices .CRB is up about 17%.

The past few weeks have brought food riots in Africa, record prices and export restrictions for rice, and even the imposition of buying limits on staples such as rice and flour at some US warehouse stores - events that should have penetrated the Fed's psyche.

“In a more normal economic downturn, another large Fed rate cut would be a given. But the huge upswing in global commodity prices complicates matters,” said Rory Robertson, interest rate strategist at Macquarie Bank in Sydney.

US economic data has been generally weak since the Fed's March 18 policy meeting, with reports showing a third straight monthly drop in employment, plunging consumer confidence and soft retail spending.

The government's initial estimate of US Q1 gross domestic product is due on Wednesday. Analysts forecast growth at a median 0.2% annual pace, with estimates ranging from minus 0.8% to plus 1.5%. (Reuters)

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