Originally created 11/04/02

Fed expected to cut rates for the first time this year



WASHINGTON -- The Federal Reserve is likely to move four-decades-low interest rates even lower this week in the face of rising worry that the struggling economy is headed for rougher times.

A series of recent economic reports has offered indications that the country's sputtering recovery is once again threatening to stall, and that leads many private economists to predict a rate cut when Fed policy-makers meet Wednesday.

"The jury is now in, and the verdict is rate cut," said Sherry Cooper, an economist at BMO Financial Group.

Most economists believe the only question mark is whether the Fed will cut its target for the federal funds rate, the interest that banks charge each other, by one-quarter or one-half of a percentage point.

The funds rate has rested at 1.75 percent since Dec. 11. That's when the central bank made its 11th rate cut in an aggressive yearlong campaign to bolster economic activity and restore growth. The Fed acted while the country was in the grips of its first recession in a decade and still suffering economic shocks from the Sept. 11, 2001, terrorist attacks.

The Fed was content to leave the funds rate at its lowest level in four decades for an extended period in the belief the low rates would work their normal magic and restore stronger growth.

Such low rates have allowed automakers to offer zero-interest financing deals that drew buyers into auto dealerships in record numbers through the summer. They also have produced the lowest mortgage rates since the mid-1960s, spurring sales of new and existing homes to record levels.

The strength in these two critical areas, however, has been insufficient to launch a sustained economic recovery. Jolts such as the corporate accounting scandals, rising oil prices and worries about possible war with Iraq have acted as strong headwinds.

The economy did rebound from lackluster growth at a 1.3 percent rate in the spring to 3.1 percent in the summer. But many forecasters believe growth will slump again in the current quarter.

The most pessimistic look for an anemic rate of 1 percent or less as the surge in consumer spending fades, especially for big-ticket items such as cars.

"We are clearly hitting a soft spot with consumers worried about everything in the world from a war in Iraq to another terrorist attack," said David Wyss, chief economist at Standard & Poor's in New York.

The government reported Friday that the jobless rate climbed to 5.7 percent in October; the number of people looking for work but unable to find it rose by 100,000 to 8.2 million. Manufacturing lost an additional 49,000 jobs, the 27th consecutive monthly decline, bringing job losses in this sector to almost 2 million.

Jerry Jasinowski, president of the National Association of Manufacturers, said the weakening economy requires a bold move from the Fed. He interprets that as a rate cut of one-half percentage point at its policy-setting Federal Open Market Committee meeting Wednesday.

"There is a great deal of uncertainty right now, and policy makers need to take the steps to encourage business lending to get this expansion back on track," he said.

While the Fed favored half-point moves in eight of its 11 cuts last year, many analysts believe it may opt for a quarter-point now, in part because rates already are so low that Fed policy-makers could be worried about running out of maneuvering room.

The expectation of a rate cut this week helped lift spirits on Wall Street, with the Dow Jones industrial average climbing by 121 points on Friday despite the bad unemployment news.

Bolstering investor confidence may be one of the biggest supports further Fed rate cuts can provide, given that interest rates have been at such low levels for so many months that much pent-up consumer demand has been exhausted.

Lowering rates also could help to change the mood on Wall Street and encourage more investors to move money from the bond market back into stocks.

Some analysts, however, believe the Fed's interest rate magic has about run its course, and it's time for the White House and Congress to end their squabbling and come up with further fiscal stimulus. That could be either increased spending in such areas as a further extension of unemployment benefits or further tax cuts to encourage business investment.

Congress comes back this month for a lame-duck session, and an extension of employment benefits to help some 800,000 people who will exhaust their benefits in late December is among options being considered.

"An extension of unemployment benefits would help the economy," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. "We are talking about a huge number of people who are facing the prospect of running out of their benefits."

On the Net: Federal Reserve: http://www.federalreserve.gov/