Fed May Cut Rate Below Inflation

The Federal Reserve may push interest rates below the pace of inflation this year to avert the first simultaneous decline in U.S. household wealth and income since 1974.
TradingEconomics.com, Bloomberg 1/29/2008 5:08:42 AM

The threat of cascading stock and home values and a weakening labor market will spur the Fed to cut its benchmark rate by half a percentage point tomorrow, traders and economists forecast. That would bring the rate to 3 percent, approaching one measure of price increases monitored by the Fed.

So-called negative real interest rates represent an emergency strategy by Chairman Ben S. Bernanke and are fraught with risks. The central bank would be skewing incentives toward spending, away from saving, typically leading to asset booms and busts that have to be dealt with later.

The Federal Open Market Committee begins its two-day meeting today and will announce its decision at about 2:15 p.m. in Washington tomorrow. Officials will also discuss updates to their three-year economic forecasts at the session.

Bernanke, 54, and his colleagues on Jan. 22 lowered the target rate for overnight loans between banks by three-quarters of a percentage point. The cut was the biggest since the Fed began using the rate as its main policy tool in 1990 and followed a slide in stocks from Hong Kong to London that threatened to send U.S. equities down by more than 5 percent.

The central bank will probably lower the rate to at least 2.25 percent in the first half, according to futures prices quoted on the Chicago Board of Trade. The chance of a half-point cut tomorrow is 86 percent, with 14 percent odds on a quarter- point.

Stocks rose in Europe and Asia today as traders anticipate the next Fed rate cut. The MSCI World Index added as much as 0.8 percent today, taking it to 1454.62. It's down about 9 percent so far this year. Futures on the Standard & Poor's 500 Index rose 0.2 percent.

Inflation, as measured by the personal consumption expenditures price index minus food and energy, was a 2.5 percent annual rate in the fourth quarter, economists estimate. The Commerce Department releases the figures tomorrow.

The last time the Fed pushed real rates so low was in 2005, in the middle of the three-year housing bubble, when consumers took on $2.9 trillion in new home-loan debt, the biggest increase of any three-year period on record.

Fed May Cut Rate Below Inflation