Wednesday, February 20, 2008

Fed Saw Need for `Relatively Low' Rates for Some Time (Update3)

By Craig Torres

Feb. 20 (Bloomberg) -- Federal Reserve officials, voting for the fastest easing of monetary policy in two decades, said ``relatively low'' interest rates may be needed for some time to counteract a faltering U.S. economy.

``Several participants noted that the risks of a downturn in the economy were significant,'' according to minutes of the Fed's Jan. 9 and 21 conference calls and Jan. 29-30 meeting. ``Many participants were concerned that the drop in equity prices, coupled with the ongoing decline in house prices, implied reductions in household wealth that would likely damp consumer spending.''

The U.S. has moved closer to a recession since policy makers last met, with payrolls shrinking, manufacturing stalling and the housing market showing no sign of recovery. At the same time, some officials also considered that a reversal of the rate cuts may be needed once the economy stabilizes, the minutes showed.

``They'd love to raise rates by the end of the year,'' said Vincent Reinhart, former director of the Fed Board's Division of Monetary Affairs, now at the American Enterprise Institute in Washington. ``They could only do it if the slowdown had been short-lived, of course.''

Policy makers cut the benchmark rate by a half-point on Jan. 30, eight days after an emergency reduction of 0.75 percentage point. The Federal Open Market Committee has lowered the rate from 5.25 percent since September, and some traders anticipate further reductions. Stocks gained and the dollar pared its advance after the minutes.

`Reason to Fear'

``The Fed has every reason to fear the possibility that the supply of credit to the private sector may prove to be inadequate, so inadequate that the U.S. slips into a recession,'' John Lonski, chief economist at Moody's Investors Service in New York, said in a Bloomberg Television interview.

Central bankers now see the economy expanding 1.3 percent to 2 percent in the fourth quarter from the same period a year before. In October, they predicted growth of 1.8 percent to 2.5 percent. The group sees the Commerce Department's gauge of consumer prices rising 2.1 percent to 2.4 percent, compared with 1.8 percent to 2.1 percent.

`Rapid Reversal'

Some members noted ``when prospects for growth had improved, a reversal of a portion of the recent easing actions, possibly even a rapid reversal, might be appropriate,'' said the minutes, released in Washington today. Still, policy makers didn't see their rate cut as adding to inflation pressures given the weakness in growth. ``Members agreed that inflation was likely to moderate in coming quarters.''

Fed officials' projections show inflation falling back to 1.7 percent to 2 percent next year and staying at that rate in 2010.

``If the Fed thinks inflation is coming back down in a year with oil touching $100, there must be one heck of a recession brewing out there,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York.

The worst housing downturn in 25 years has damaged bank earnings, resulting in tighter credit and slowing growth. A government report today showed that housing starts remained near their lowest level since 1991 in January.

``As had been the case in some previous cyclical episodes, a relatively low real federal funds rate now appeared appropriate for a time,'' the minutes said today. So-called real rates are those adjusted for the pace of inflation.

Traders anticipate the Fed will lower the target rate for overnight loans between banks by another half-point by the end of the next meeting, on March 18.

Credit `Tightening'

``The availability of credit to consumers and businesses appeared to be tightening, likely adding to restraint on economic growth,'' the minutes said.

The Fed's Jan. 22 rate cut followed a videoconference at about 6 p.m. the previous evening. Officials gathered after a sell-off in global stock markets from Hong Kong to London threatened to send the S&P 500 down as much as 5.3 percent.

The three-quarter point move was the biggest single reduction since the Fed began using the federal funds rate as its principal policy tool about 1990. The cut was conducted to ``begin aligning the real policy rate with a weakening economic situation,'' the minutes said. Some officials were concerned that the cut ``could be misinterpreted as directed at recent declines in stock prices.''

Default Protection

Some credit markets have remained under stress even after the Fed's rate cuts. The cost of protecting corporate bonds from default soared to a record today.

Credit-default swaps on the Markit CDX North America Investment-Grade Index of 125 companies with ratings above junk jumped as much as 13 basis points to 167.25. A basis point is 0.01 percentage point.

Since the beginning of 2007 through the end of January, financial institutions have posted $146 billion in credit losses and asset writedowns.

The faltering economy has yet to damp inflation, government figures indicated today. The Labor Department's measure of consumer prices rose 4.3 percent in January from a year ago, up from a 4.1 percent rate in December. Stripping out food and energy, the core gauge rose 2.5 percent, the most since March.

Rising energy and commodity costs, along with food prices, are pushing up inflation. Crude oil rose to a record $100.10 a barrel yesterday.

Sales of existing homes fell 13 percent last year, the biggest slump in 25 years, and prices dropped 1.8 percent, the first decrease since records began in 1968.

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