Fed Slices Rates to Avoid A Downturn

By Neil Irwin
Washington Post Staff Writer
Thursday, November 1, 2007

The Federal Reserve cut a key interest rate yesterday, continuing its campaign to keep the troubled housing market from causing a broad economic downturn. But the central bank also said it was worried that rising energy prices would lead to higher inflation -- a hint that it won't necessarily cut rates further in the coming months.

The rate cut will make it cheaper for consumers to borrow money via credit cards, auto loans and many home mortgages, and make it easier for companies to expand by taking on debt -- effects the Fed is hoping will stimulate the economy. Markets rallied on the news, but many analysts interpreted the fine print of the Fed's statement to indicate that they should not assume the central bank will keep cutting rates.

"They're saying to the markets: 'We gave you what you wanted today, but don't ask for another cookie,' " said Scott Anderson, a senior economist at Wells Fargo.

Growth has been solid in recent months -- a government report yesterday said that the economy grew at a stronger-than-expected 3.9 percent annual rate in the third quarter -- but the central bank indicated that it was worried that the good times won't last.

That's why the policymaking Federal Open Market Committee lowered the federal funds rate, a rate at which banks lend to one another, a quarter of a percentage point, to 4.5 percent. That followed a half-percentage point cut in September.

After wobbling initially, the Dow Jones industrial average ended the day up 137 points, or 1 percent. Investors generally favor rate cuts because they lower companies' cost of borrowing and might help avert an economic slowdown.

"The pace of economic expansion will likely slow in the near term," the policymakers said in a statement. But they added that the two rate cuts "should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time."

They also acknowledged the rapidly rising price of oil and other raw materials. Yesterday, oil traded at an all-time high of $94.53 per barrel, reflecting news that U.S. inventories had fallen sharply. "Recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation," the statement said. As a result, it said, "the upside risks [of] inflation roughly balance the downside risks to growth."

That language told economists that the central bank's next moves are up in the air. Yesterday's rate cut brought short-term interest rates to roughly what Fed leaders consider the "neutral rate," or the level that neither stimulates nor slows the economy.

Thus, what the Fed does next will depend on whether new data over the coming months indicate that inflation is heating up (in which case it might raise rates) or that growth is about to slow significantly (in which case it might cut them further).

"They've bought themselves flexibility," said Vincent R. Reinhart, a resident scholar at the American Enterprise Institute who until September was a top economist at the Fed. "They're saying they've got risks on both sides."

Many economists said yesterday that they expect Fed policymakers to leave rates unchanged at their next meeting, Dec. 11.

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