Fed rate cut pleases investors

Federal Reserve Chairman Ben Bernanke and his critics in financial markets may finally be on the same page.

The central bank reduced its benchmark interest rate by half a point to 3 percent on Wednesday, eight days after an emergency three-quarter point move, the fastest easing of monetary policy since 1990. The Fed left the door open to more cuts by saying in its statement that "downside risks to growth remain".

The decisions alleviated some of the criticism investors and economists have directed at the Fed since August, when it was still saying inflation was the "predominant" risk. Bernanke, who today marks the midpoint of his four-year term, played down price increases in last month's statements.

"Now that the language and the moves are coordinated and they're moving very aggressively, it's hard for anyone to say the Fed isn't on top of things," said Ethan Harris, chief US economist at Lehman Brothers Holdings Inc. Last year, investors found Bernanke reluctant to lower rates to offset a credit squeeze and found some of his statements confusing, said Harris, a former New York Fed research manager.

The half-point reduction in the target rate for overnight loans between banks matched the forecast of the majority of economists in a Bloomberg News survey.

Traders expect policymakers to reduce the rate to 2.25 percent by mid-year, according to futures contracts quoted on the Chicago Board of Trade.

'Strong leadership'

"What the Fed is telling us is they have come to recognize that they were behind the curve, that they put more emphasis on inflation than was warranted," said former Fed Governor Lyle Gramley, who's now a senior adviser at Stanford Group Co in Washington. "This is a case now of Bernanke realizing that he really has to be exercising very strong leadership."

Bernanke signaled the shift in a Jan 10 speech, stressing that "we stand ready to take substantive additional action as needed", a message lacking from Federal Open Market Committee statements since September.

Last year, Bernanke opted to tackle a surge in banks' funding costs by lowering the rate on direct loans to banks and introducing a tool to auction funds to lenders, instead of more aggressive cuts in the benchmark rate.

Now, he is using the federal funds rate to address broader, deeper declines in stocks and housing, aiming to avoid the first recession since 2001. The Standard & Poor's 500 Index has fallen 14 percent from its October peak.

"Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the FOMC said.

Bernanke now looks "pre-emptive and ahead of the curve, having cut 125 basis points in two weeks", said Steven Einhorn, vice chairman of Omega Advisors Inc, a New York-based hedge fund with about $5 billion under management. Earlier this month, he called the central bank "tame, timid and tardy".

The decision came hours after government figures showed growth slowed to an annualized rate of 0.6 percent, down from 4.9 percent in the previous three months.

"This ought to be enough, with any luck at all, to avoid a recession and put us back into fairly solid growth in the latter half of the year," said Gramley, who predicted Wednesday's rate cut will prove to be the last.

At the same time, Bernanke may have earned himself fresh criticism from some economists who claim he has gone soft on inflation and risks unleashing new asset booms and busts.

"This Fed hasn't shown the willingness to disappoint financial markets and the expectations of rate cuts," said John Ryding, chief US economist at Bear Stearns Cos in New York.

Agencies

(China Daily 02/01/2008 page17)