The Wall Street Journal-20080111-Fed Chief Opens the Door To -Substantive- Rate Cuts
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Fed Chief Opens the Door To 'Substantive' Rate Cuts
Federal Reserve Chairman Ben Bernanke, citing the growing threat to the economy from fragile financial markets and weakening employment, opened the door to "substantive" cuts in U.S. interest rates.
Mr. Bernanke's comments yesterday suggested that after months of being out of step with the nation's markets, the Fed is drawing closer to their view that much lower rates are needed to keep the economy from stalling, despite the risk that rate cuts could fuel inflation.
In a speech that reflected more urgency about the economy than he has expressed since August, when the current credit crunch began, Mr. Bernanke strongly hinted the Fed would reduce its short-term interest- rate target, probably by half a percentage point from its current 4.25%, at the central bank's next meeting, Jan. 29-30. While the Fed could act before then, it would be unlikely to do so in the absence of a dramatic deterioration in the markets or exceptionally bad economic data.
Mr. Bernanke told Women in Housing and Finance and the Exchequer Club in Washington that inflation remained a concern but indicated that wouldn't stand in the way of lower interest rates. The "outlook for real activity in 2008 has worsened, and the downside risks to growth have become more pronounced," Mr. Bernanke said. "In light of recent changes in the outlook for and the risks to growth, additional policy easing may well be necessary."
Stocks rallied on the news, with the Dow Jones Industrial Average gaining 117.78 points to close at 12853. Bond prices plunged and yields, which move in the opposite direction, rose. The dollar slumped against the euro, which got a lift from the European Central Bank's decision yesterday to hold euro-zone interest rates steady.
One news service published highlights of Mr. Bernanke's speech about 45 minutes before their scheduled release. The surprise may have accentuated the market impact.
Mr. Bernanke stressed in his remarks that the Fed could act quickly: The central bank must "remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability."
While some Fed watchers took that as a hint a rate cut might be coming within days, it more likely emphasizes Mr. Bernanke's willingness to change rates rapidly if circumstances warrant -- including raising rates later if inflation accelerates.
The speech comes at a crucial time for the Fed. Mr. Bernanke noted that until last spring the central bank thought it was facing "the classic problem of managing the midcycle slowdown" -- guiding the economy from rapid to slower growth in order to keep inflation in check. But the dramatic deterioration in housing and credit markets since then has significantly raised the risk of recession -- an outright contraction of economic activity and employment lasting at least six months.
In the latest monthly survey by The Wall Street Journal, private forecasters on average put the odds of recession in the next 12 months at 42%, up from 23% just six months ago.
Responding to questions, Mr. Bernanke said, "The Federal Reserve is not currently forecasting a recession. We are forecasting slow growth. But . . . it's very important for us to stand ready . . . to address those risks and provide some insurance against those negative outcomes."
The inflation picture makes the Fed's job more complex. Since August, the central bank has either said it was equally worried about the risks of weaker growth and inflation, or refused to say which was more worrisome. That equivocation reflected the fact that food and energy prices are soaring; that inflation -- both with and without food and energy -- by most measures remains above Fed policy makers' preferred range of 1.5% to 2%; and that the economy is less able to grow rapidly without inflation than it was earlier this decade.
Mr. Bernanke noted that rising food and energy prices have pushed up inflation and while the public's expectations of inflation "have remained reasonably well-anchored . . . any tendency of inflation expectations to become unmoored or for the Fed's inflation-fighting credibility to be eroded could greatly complicate" the central bank's task in the future.
Those comments make it unclear whether the Fed is prepared to formally declare that weak growth is a bigger worry than inflation.
Inflation concerns figured in yesterday's decisions by the ECB and the Bank of England to leave their interest-rate targets at 4% and 5.5%, respectively.
ECB President Jean-Claude Trichet suggested at a news conference following the ECB's meeting that the threat of higher inflation remains the central bank's top concern. Euro-zone consumer-price inflation in November and December was at a 6 1/2-year high of 3.1%, well above the ECB's goal of just under 2%, and policy makers expect high food and energy prices to keep the rate elevated in coming months. Mr. Trichet warned the ECB "is monitoring wage negotiations . . . with particular attention."
Mr. Trichet also suggested that policy makers' expectations of economic growth had shifted down somewhat. Yesterday, both France and Spain reported major declines in industrial production that echoed previously reported drops in Germany.
The Bank of England will release minutes of yesterday's meeting on Jan. 23. They are expected to show the bank kept rates steady because of inflation concerns -- including fresh utility-price increases and the pound's 7% fall against the dollar since November.
Mr. Bernanke's speech dwelled far more on risks to the economy than inflation. Home demand has "weakened further," while "higher oil prices, lower equity prices, and softening home values seem likely to weigh on consumer spending," he said.
The U.S. employment report for December, which showed a decline in private-sector jobs, was "disappointing," Mr. Bernanke added. Previously, "relatively steady gains in wage and salary income [were] providing households the wherewithal to support moderate growth" in spending. "Should the labor market deteriorate, the risks to consumer spending would rise," he said.
The increase in the nation's unemployment rate to 5% last month from 4.7% in November suggests one source of inflation risk -- tight labor markets -- is receding. "Pressures on resource utilization have diminished a bit," Mr. Bernanke said.
The Labor Department said yesterday that initial claims for unemployment benefits fell 15,000 to 322,000 last week, the second straight decline, suggesting the labor market isn't deteriorating dramatically.
Mr. Bernanke noted the Fed had taken numerous steps to ensure financial institutions felt they had adequate funds, including the creation of a new "term auction facility" for supplying cash directly to banks. These efforts "had some positive effects," he said. Indeed, interbank lending rates have come down sharply in recent weeks.
The Fed reported yesterday that direct loans from its "discount window" to healthy banks fell sharply to $1.015 billion in the week ended Wednesday from $4.9 billion the previous week, probably reflecting the declining cost of borrowing in the interbank loan market.
But Mr. Bernanke said the financial situation remained "fragile." Private-sector analysts agreed. Doug Duncan, chief economist of the Mortgage Bankers Association, said conditions in mortgage markets "are not getting better, they're not necessarily getting worse." For example, he said there hasn't been a significant resumption in issuance of securities backed by prime, jumbo mortgages -- those above $417,000 -- other than a bit for the highest-rated pieces of such securities. That market is an important source of funds for home purchases, especially in high-priced markets like California.
Economists from J.P. Morgan Chase said that while a rate cut would "have limited effect on household and business spending in the very near term . . . more aggressive Fed action, when combined with the high likelihood that fiscal stimulus will be implemented after midyear, could have a substantial effect on growth in the second half of the year."
