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Inflation pressures override need to boost slowing growth

(WASHINGTON) Federal Reserve officials strongly suggested they won’t be inclined to cut interest rates further even as they sharply downgraded their forecast for economic growth this year. They cited damage from a housing slump, credit crunch and galloping energy prices for the slow growth.

In fact, the Fed’s decision to lower interest rates at its April 29-30 meeting was a ‘close call’, according to minutes of those private deliberations released on Wednesday.

The Fed hopes that its series of powerful rate cuts ordered since last September and the government’s US$168 billion stimulus package of tax rebates for people and tax breaks for businesses will help energise growth somewhat in the second half of this year.

Fed officials viewed economic activity ‘as likely to be particularly weak in the first half of 2008; some rebound was anticipated in the second half of this year’, the documents stated.

The Fed also forecast higher unemployment and inflation for this year.

Given the hope of a second-half economic pickup but worried about inflation, Fed officials signalled last month that their one-quarter-point rate reduction, which dropped their key rate to 2 per cent, might be their last rate cut for some time.

‘Most members viewed the decision to reduce interest rates at this meeting as a close call,’ the documents showed. ‘Although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices.’

Many economists believe the Fed will hold its key rate steady when it meets next, on June 24-25.

That sentiment was borne out in the Fed’s documents as well as recent speeches by Fed officials.

Looking ahead, some Fed members - not identified in the documents - noted that it was ‘unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term, unless economic and financial developments indicated a significant weakening in the economic outlook’, according to the Fed papers.

Separately, Fed governor Kevin Warsh, in remarks on Wednesday, also suggested that the Fed was not inclined to cut rates again. ‘Even if the economy were to weaken somewhat further, we should be inclined to resist expected, reflexive calls to trot out the hammer again.’

Under its new projections, the Fed now believes that gross domestic product will grow between just 0.3 per cent and 1.2 per cent this year.

That’s lower than a Fed forecast, released in late February, that estimated growth to be between 1.3 per cent and 2 per cent.

With economic growth slowing, the Fed projected that the national unemployment rate will rise to between 5.5 per cent and 5.7 per cent this year. That is higher than the central bank’s old forecast for the rate to climb as high as 5.3 per cent. Last year, the unemployment rate averaged 4.6 per cent.

And, with energy prices marching upwards, the Fed raised its projection for inflation. The Fed now expect inflation to be between 3.1 per cent and 3.4 per cent this year. That’s higher than its old forecast of 2.1 per cent to 2.4 per cent.

At the Fed meeting in April, two members - Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and Richard Fisher, president of the Federal Reserve Bank of Dallas - opposed cutting rates, a crack in the usually unified front the Fed often shows the public.

Both men have a reputation for being especially vigilant about fighting inflation. And, some fear that further rate cuts could aggravate inflation.

Wednesday’s report may have raised investor concerns about stagflation, the combination of stagnant growth and high inflation seen in the 1970s, said Keith Hembre, chief economist at Minneapolis-based FAF Advisors. — AP, Bloomberg

Source : Business Times - 23 May 2008