April 30, 2008

 

WASHINGTON - The Federal Reserve, noting a "weak" economy, Wednesday cut short-term interest rates a modest quarter percentage point, extending its seven-month campaign to keep the economy from tumbling into a potentially deep recession.

But rising food and energy prices could limit the Fed's ability to cut rates much further in coming months, economists say.

The central bank noted as much, releasing a statement that said "Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months."

After a two-day meeting, central bank policymakers led by Fed Chairman Ben Bernanke cut the benchmark overnight lending to its lowest level in more than three years. The move will translate into slightly lower rates for many consumer and business loans including some credit cards, adjustable mortgages and home equity lines.

The Fed's decision came after the government reported that the economy limped along with a growth rate of just 0.6 percent in the first quarter, the same anemic rate as in the final quarter of 2007. The preliminary report suggests that economic production is at near-recession levels. (Recessions are formally declared by a committee of economists, often well after the fact.)

Fed policymakers confront a bleak landscape with an economy moving sideways, consumer confidence at new lows, a deep housing downturn and lingering malaise in financial markets.

The Fed has taken a series of aggressive actions, cutting short-term rates seven times since mid-September, including an aggressive three-quarters of a point last month. And the Fed has pumped money into financial markets in other ways, helping Wall Street investment banks that are reeling from problems in the credit market.

In addition to lowering rates to spur the economy, the central bank has rolled out a series of emergency steps to pump billions of dollars of liquidity into financial markets to beat back a credit crunch. Policy-makers also will debate a new liquidity tool — paying interest on bank reserves — on Wednesday.

Fresh evidence of clouds over the economy emerged on Tuesday, with reports showing consumer confidence at a five-year low this month, a continued slide in existing home prices in February and a 23 percent surge in foreclosures in the first quarter.

At the same time, with 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 support the economy could lead the central bank to take its eyes off inflation.

Two officials dissented from the central bank's decision in March to cut rates by three-quarters of a percentage point, preferring a less aggressive move.

The Fed's rate cuts have led to a weakening in the U.S. dollar that has pushed import prices higher, adding to inflation pressures. But Fed officials believe unemployment is likely to climb amid the economy's weakness, making it difficult for businesses to raise their prices.

Policy-makers also expect the combined effects of the central bank's rate cuts — which act with a lag — and a $152 billion fiscal stimulus package will provide a boost to the economy in months to come.

“The disinflationary effect of a weak domestic economy and rising slack will ultimately dominate the inflation boosting impact of higher commodity prices and dollar depreciation,” UBS economist James O'Sullivan wrote earlier this week in a note to clients.

Full statement

The text of the full statement is below:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

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 Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.