Fed to hold fire amid market turmoil

September 14, 2008
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, WASHINGTON, September 14 – The Federal Reserve is likely to maintain its simulative interest rate policy on Tuesday in the face of renewed market turmoil and signs that the US economy remains in a funk, analysts say.

The Federal Open Market Committee (FOMC) headed by chairman Ben Bernanke is widely expected to maintain the federal funds rate at 2.0 percent, where it has been since April 30, even though that is below the pace of inflation.

The panel also is expected to shift gears, backing away from a pledge to lift interest rates at some point soon, despite hints since June that inflation is its main concern.

"The Fed clearly cannot raise rates — that would send the economy and financial markets into a tailspin," said Sal Guatieri, senior economist at BMO Capital Markets.

"The market is pricing in a minimal chance of a rate cut, but I think that\’s fairly unlikely," Guatieri said.

"The Fed will express ongoing concerns about the economy given only tentative signs of stabilization in certain pockets of the housing market. And it probably will express less concern about inflation given the turn in commodity prices and import prices."

The US central bank has been projecting weak economic growth in 2008 and into 2009 amid a horrific housing slump and related credit squeeze, despite data showing a 3.3 percent spurt in growth in the second quarter.

The Fed\’s Beige Book report earlier this month highlighted troubles facing US consumers, affecting spending that accounts for some two-thirds of economic activity. It said spending was slow consumers focused on "necessary items" and "retrenchment" in discretionary purchases.

On top of that, the troubles in the financial sector, illustrated by the government decision to take over sputtering mortgage finance giants Fannie Mae and Freddie Mac, show that the credit crisis is not over, making an economic rebound unlikely.

In view of this, analysts say there is little the central bank can do.

"We believe the Fed will remain on extended hold as the current level of funds is consistent with the type of economic scenario we envision, namely, negligible economic activity, rising unemployment, and declining inflation," said Joseph LaVorgna, economist at Deutsche Bank.

"Next week\’s FOMC statement is likely to make a subtle nod that the inflation backdrop has improved, albeit only mildly in the collective mind of the Fed."

Cary Leahey, senior economist at Decision Economics, said a rate cut would probably do little to stimulate a flagging economy because credit is difficult and the existing low rates have failed to filter down to consumers and businesses.
"Right now the Fed is pushing on a string," Leahey said.

"Given the convulsions in the market, people aren\’t so sure policy is accommodative."

Avery Shenfeld, economist at CIBC World Markers, said a rate cut "is highly unlikely and would in any event be unhelpful" since "lingering inflation fears could negate its benefits."

"Still, the FOMC will lower its guard on inflation a bit, and will sound more worried about prospects for growth," Shenfeld added.
Analysts said Fed policy has been torn between the "hawks" who fear an upsurge in inflation pressures from the low rates and "doves" who see a weak economy that still needs what Fed officials call "accommodative" rates to stimulate activity.

The most recent economic reports — a 0.9 percent drop in wholesale prices and a 0.3 percent decline in retail spending — may give some ammunition to the doves.

"Softer commodity prices, a firmer greenback and weak demand will likely drive producer and consumer inflation lower in the months ahead," Guatieri said.

"This opens the door a crack for renewed Fed easing if the economy takes a turn for the worse."

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