Fed May Be Done Cutting as Inflation Risk Increases (Update1)

By Scott Lanman


Nov. 1 (Bloomberg) -- Federal Reserve officials may be done cutting interest rates after voicing new inflation concerns and signaling they won't be surprised by further housing weakness.

Chairman Ben S. Bernanke and his colleagues cut the benchmark rate yesterday by a quarter point to 4.5 percent and said risks of higher prices and slower growth are ``roughly'' balanced. They warned that energy and commodity prices may place ``renewed upward pressure on inflation.''

The Federal Open Market Committee's statement indicates policy makers expect the six-year expansion to survive the deepening housing recession. Investors got the message, as stocks rallied, Treasuries dropped and futures contracts began removing expectations of a third rate cut next month.

``They're on hold for the foreseeable future, and the clearest signal of that was the move to a balanced bias,'' said Dean Maki, chief U.S. economist at Barclays Capital in New York and a former senior economist at the Fed. Bernanke's team was ``indicating clearly'' that they have already taken into account the prospect of slower growth, Maki said.

Maki said the Fed will keep borrowing costs unchanged until the second half of 2008, when he expects it to raise rates.

The combined 0.75 percentage point of reductions between Sept. 18 and yesterday ``should help forestall some of the broader effects on the economy'' from financial-market turmoil, the FOMC said. It is the sharpest reduction in rates since the economy was emerging from the last recession in 2001.

Dissenting Vote

In another sign of increasing anxiety that inflation will pick up, the FOMC had its first dissenting vote since December. Kansas City Fed President Thomas Hoenig preferred no change in the overnight lending rate between banks.

Just six of the 12 district banks requested an accompanying quarter-point reduction in the discount rate, the charge for direct loans to banks. Last time, seven banks had sought a half- point cut.

``The concern here is the possibility of backtracking on the progress they have seen this year'' on inflation, said Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington, who used to work at the Fed. ``It is hard to believe that we will see a convincing case by the December meeting'' for another cut.

The Fed's preferred inflation measure rose 1.8 percent in September from a year before, the Commerce Department said today. That's near the top of the 1 percent to 2 percent ``comfort'' range Bernanke said he favored before becoming chairman.

Inflation Report

It was the second straight month that the gauge, the personal consumption expenditures price index, minus food and energy, rose by that much, after two months of 1.9 percent gains.

Bernanke will have a chance to expand on the Fed's outlook when he testifies before Congress's Joint Economic Committee on Nov. 8. Democratic Senator Charles Schumer of New York announced the hearing yesterday.

Fed officials made their decision hours after Commerce figures showed growth unexpectedly accelerated to an annual pace of 3.9 percent in the third quarter, the fastest in more than a year. Economists predicted the expansion will slow to 1.8 percent this quarter, according to a Bloomberg survey published Oct. 10.

``Growth was solid in the third quarter, and strains in financial markets have eased somewhat,'' the FOMC said. At the same time, officials said they recognized that ``the pace of economic expansion will likely slow in the near term,'' in part because of the ``intensification of the housing correction.''

Housing Recession

Housing has slipped deeper into recession since the credit- market collapse made it harder to obtain loans. Sales of previously owned homes fell in September to an annual rate of 5.04 million, the lowest since records began in 1999, the National Association of Realtors said last week. Housing starts fell to a 14-year low.

``Unless they see something they don't now anticipate, they're going to sit on their hands for a while,'' said former Fed Governor Lyle Gramley, now senior economic adviser at Stanford Group Co. in Washington. ``What it would take for another rate cut to come along is evidence that consumer spending is really heading south, big time.''

While the Fed didn't specify concern about currency exchange rates, officials at the Sept. 18 meeting judged price ``risks could be heightened if the dollar were to continue to depreciate significantly,'' minutes of the session showed.

The dollar dropped this week to its lowest level since 1996, according to a Fed index that compares it against the currencies of major U.S. trading partners.

Next Meeting

Odds of a quarter-point cut in the benchmark rate at the Dec. 11 meeting receded to 40 percent yesterday, from 66 percent the day before, according to futures contracts quoted on the Chicago Board of Trade.

The statement offers an ``escape route'' to raise interest rates if needed, said Vincent Reinhart, who was Bernanke's chief monetary-policy adviser before leaving the Fed in September to join the American Enterprise Institute in Washington as a resident scholar.

``They held the risks to be balanced, to show that they could envision the next move to be in either direction,'' said Reinhart, who led the monetary affairs division from 2001.