Fed Cuts and Signals Halt

Video
The Federal Reserve cuts a key interest rate by a quarter point, a smaller move than drops in the past. But it says economic activity remains weak. Video by AP

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By Neil Irwin
Washington Post Staff Writer
Thursday, May 1, 2008

The Federal Reserve cut a key interest rate yesterday by a quarter of a percentage point, its latest step to try to bolster the ailing U.S. economy. But the modest cut came with a strong signal that the Fed's seven-month rate-cutting campaign is probably over for now.

On the same day that a new report indicated the economy grew at a meager but better-than-expected 0.6 percent annual rate in the first quarter, the Fed made clear that it was entering a new stage of assessing how much its aggressive actions -- this is the seventh rate cut since September -- combined with fiscal stimulus checks being mailed this month would help the economy.

Yesterday's action lowered the federal funds rate, at which banks lend to each other, to 2 percent. That is likely to eventually lead to lower borrowing costs for someone taking out an adjustable-rate mortgage or using a credit card, or for a business seeking money to expand. The goal is to prevent the economic downturn from becoming severe and prolonged.

"This move is buying insurance against a deeper recession," said Arun Raha, senior economist at Swiss Re.

In a statement accompanying the action, the Fed conveyed, in the ever-so-subtle language of central banking, that it was not planning more rate cuts. The statement omitted a sentence from the Fed's last communication on March 18 that "downside risks to growth remain." The Fed said yesterday that it would "act as needed" to promote growth, whereas the phrasing in March was "act in a timely manner as needed." And yesterday's statement said that the "substantial" rate cuts to date should help promote moderate growth over time, wording that carried an air of summing up past Fed actions.

As Fed-watchers parsed every comma of the statement, the message came through loud and clear.

"They're saying, 'Look, we've had monetary policy on steroids for the last few months, but that is changing now,' " said Christian Menegatti, an analyst at RGE Monitor.

But by phrasing its inclination to pause with such restraint, the Fed was trying to remain flexible. If the economy were to deteriorate even more than is now forecast, or the crisis in financial markets deepens, the interest rate cuts would almost certainly resume.

That could help avoid past communications missteps, notably in October, when the central bank cut rates but said that the risks of inflation and growth were "roughly balanced," a fairly explicit statement that it was done cutting rates. When the financial markets entered a period of renewed crisis in the ensuing weeks, there was confusion in the markets about whether the Fed would respond aggressively.

"This doesn't guarantee anything to anyone," said Drew Matus, a senior economist at Lehman Brothers, referring to the statement yesterday. "They did keep their options open."

Leaders of the Fed are worried that high inflation, driven by higher prices for food and energy, will significantly raise Americans' expectations of future inflation, which can be self-fulfilling. Continued rate cuts could cause the value of the dollar to fall further, worsening a source of inflation.

"Energy and other commodity prices have increased," said the statement from the Federal Open Market Committee, the Fed's policymaking arm, "and some indicators of inflation expectations have risen in recent months."


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