Fed Boss Hints at More Interest Rate Cuts

Federal Reserve Chairman Ben Bernanke, worried about growing unemployment and financial jitters, said Thursday the economy might need a boost from "substantive" cuts in interest rates.

That left investors speculating on whether "substantive," defined by Webster’s as meaning "of considerable amount," suggests the Fed will lower short-term interest rates by a quarter of a percentage point or by a half at its next meeting, Jan. 29 and 30.

Some economists suggested the cuts could continue for much of the first half of the year and maybe longer.

Initially, stock prices rocketed up on hopes for a big rate cut. But then they receded as investors reconsidered what Bernanke might have meant in his speech to the joint luncheon of two groups, Women in Housing and Finance and the Exchequer Club.

By the close of trading Thursday, stocks were back up, with the Dow Jones industrial average rising 117.78 to 12,853.09, as most people concluded Bernanke was indeed signaling a rate cut of half a percentage point this month.

"The outlook for real activity in 2008 has worsened, and the downside risks to growth have become more pronounced," Bernanke said. That means lower interest rates "may well be necessary."

Since September, the Fed has cut its benchmark federal funds rate from 5.25 percent to 4.25 percent. This is the rate that typically affects consumers’ pocketbooks, such as credit card rates and home equity loans.

Adam York, an analyst with Charlotte, N.C.-based banking company Wachovia, told a group of commercial real estate professionals Thursday in Norfolk he would expect a series of three quarter-point reductions: one late this month, a second in March and a third by the end of the second quarter.

"Bernanke was very clear: He rang a siren call. The economy is ailing and it needs stronger medicine – a good shot of adrenaline," said Brian Bethune, economist at Global Insight. He predicts a half- point cut this month, followed by other reductions that would lower the Fed’s key rate to 3.25 percent by the late spring.

Economists from the Goldman Sachs Group Inc. predicted an even lower floor. They say the Fed will lower the rate to 2.5 percent by the end of the year. The bank also joined Merrill Lynch & Co. and Morgan Stanley in projecting a recession.

Despite his scenario, York warned "the Fed may be in a position to hike rates by the end of the year," if it senses that inflationary pressures build.

For some time, the Fed has been trying to figure out which is the bigger risk: inflation or recession. If the central bank cuts interest rates too much, it could overstimulate the economy, driving up demand for oil, gasoline and other already expensive commodities. Low interest rates also weaken the U.S. dollar and make imported goods more costly for consumers.

But if the Fed fails to cut interest rates enough, it could allow the economy to slide into recession. In December, hiring practically ground to a halt nationally, with unemployment rising to 5 percent, a two-year high.

"It would be a mistake to read too much into any one report," Bernanke said of the December jobs report. "However, should the labor market deteriorate, the risks to consumer spending would rise."

"The Federal Reserve is not currently forecasting a recession," Bernanke said later, fielding questions after his speech Thursday. It is, however, "forecasting slow growth," he said.

Also Thursday, top economists met at the Brookings Institution, a think tank, to discuss proposals. Mark Zandi, the chief economist at Moody’s.com, said Congress should extend unemployment insurance while the economy goes through this tough time.

But Harvard University Professor Martin Feldstein said it would be better to offer a tax rebate to "put cash into people’s pockets that they will spend."

Former Fed Chairman Alan Greenspan, who ran the Fed for 18 1/2 years, recently warned that the economy is "getting close to stall speed." Some economists said the odds of a recession are up to 50 percent.

The housing slump – aggravated by harder-to-get credit – has weighed heavily on national economic activity. Foreclosures have soared to record highs and financial companies have piled up multibillion losses because of bad mortgage investments. The situation raises the biggest challenge yet to Bernanke, who took over the Fed in February 2006.

Investors typically cheer rate cuts, which grease the wheels of the economy by making it easier for banks and businesses to lend to consumers and one another. But Bernanke’s starkly negative forecast for 2008 might have trumped investors’ short-term hopes by raising the specter of a long-term slowdown in spending.

The Fed has tried to counter the credit crunch by starting a system of anonymous auctions, which allow banks to borrow money from the government without the stigma of appearing desperate for credit. Bernanke said the new program, known as the Term Auction Facility, has been successful and "may thus become a useful permanent addition to the Fed’s toolbox," pending a public vetting.

This story was compiled from reports from Cox Newspapers, Bloomberg News, The Associated Press, The New York Times and Virginian-Pilot staff writer Tom Shean.

what he said

In a speech Thursday, Federal Reserve Chairman Ben Bernanke, above, said lower interest rates might soon be necessary. "The outlook for real activity in 2008 has worsened, and the downside risks to growth have become more pronounced," he said. The Federal Reserve’s next meeting is Jan. 29 and 30. the reaction

Initially, stock prices rocketed up on hopes for a big rate cut, but they later receded as investors reconsidered what Bernanke might have meant in his speech. By the close of trading Thursday, stocks were back up, as most people concluded Bernanke was indeed signaling a rate cut of half a percentage point this month.