Fed Drops Interest Rates Another Quarter Point

The US Federal Reserve has cut interest rates yet again. The Fed Funds rate is now at 2%. Back in mid-September the rate was 5.25%. Thus far, the Fed has managed to fend off recession; the Commerce Department says GDP actually grew in the first quarter by 0.6%. That’s anemic, but it’s growth. There are only a few basis points before zero, and the dollar isn’t going to strengthen when interest rates are low. So, the question now becomes “what next?”

In the immediate term, one can expect the Fed to pause in its reduction of rates. Dropping rates as quickly as it has means there has been little time to assess the effects of the previous 1:20 PM 5/1/2008reductions. The Fed also needs to end the one-way bet speculators have had since September when it was clear that US interest rates needed to come down to prevent a banking system meltdown. A pause would accomplish that.

In its statement yesterday, the Fed noted “Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.” That bears repeating: bad stuff will hang around for “the next few quarters.” There will be no economic surge ahead but sluggish growth (if there’s growth at all).

On the inflation front, the Fed is actually pretty relaxed. It “expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.” Fed watchers know that that is pretty dovish.

During the next few quarters, then, the Fed thinks the economy is going to move forward slowly and without significant increases in inflation. If so, one can expect the 2% interest rate to hold until one of two things occurs. If the economy posts negative growth three months from now, there will be a cut to 1.5% or 1.75% depending on the severity of the shrinkage. Alternatively, if growth tops 1% and inflation starts ticking up, one ought to expect a quick 0.25% increase as a shot across the bows.

© Copyright 2008 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.

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