Tue, May 08, 2007 page10

• Fed likely to hold fire on rates, analysts say

  CENTER OF INTEREST Weak economic data, however, continues to increase the odds that the Fed would cut rates more aggressively than the market has currently priced in

  • AFP
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  Despite a sputtering US economy, the Federal Reserve is likely to hold fire on interest rates as it waits for either an easing of inflation or a pickup in growth, analysts say.

  No change in rates is expected at Wednesday's meeting of the US central bank's Federal Open Market Committee (FOMC), which has held its base rate steady at 5.25 percent since last June.

  Yet some analysts are still holding out hope that the Fed will open the door to a rate cut sometime this year if conditions continue to soften.

  Some recent data has been surprisingly sluggish -- GDP for the first quarter was a tepid 1.3 percent, and last month produced a net gain of just 88,000 new payroll jobs.

  Meanwhile US home sales showed their biggest monthly fall in over 18 years in March, suggesting that the biggest drag on US economic activity is not over.

  But other recent data has been firmer -- surveys on manufacturing and services have been above expectations, and factory orders rose 3.1 percent in March.

  Inflation indicators remain a bit too hot for the Fed, which had brought rates up after of a long period of stimulation since 2001. Consumer prices were up 0.6 percent in March even though "core" prices, excluding food and energy, have been tamer.

  Joel Naroff of Naroff Economic Advisors said he remained "hopeful, though not overly confident," about a message suggesting rates may be headed lower.

  "There is little doubt that no change will be made in rates," Naroff said.

  But he added that "the softer job gains and slowing wage increases would allow the [FOMC] members to hint at a potential rate cut. But they have not been that forthcoming in their comments so I suspect there may be some disagreement on how to proceed."

  Gary Thayer, chief economist at AG Edwards, said he sees the Fed cutting rates this year if the economy fails to re-accelerate.

  "If the economy continues to grow at a subpar rate this year as we expect, the risk of inflation is likely to decline," Thayer said. "Core consumer-prices inflation has also moved down toward the Fed's 1 percent to 2 percent comfort zone and could be down into that zone by later this year. Therefore, we continue to believe the Fed will cut short-term interest rates two or three times before the end of the year."

  Scotiabank's Camilla Sutton said the weak data "continues to increase the odds that the Fed cuts more aggressively than the market has currently priced in."

  The combination of weak GDP, lower core inflation and an uptick in the jobless rate "creates an environment where the likelihood of Fed cuts has increased," she said.

  Joseph Balestrino at Federated Investors said he sees no action for now until the economic picture is clearer.

  "There doesn't seem to be a need for rate action. The economy doesn't appear to need the stimulus a rate cut would provide," he said.

  Balestrino said the soft conditions were in the first three months of the year and that "the Fed has said it expects the economy to re-accelerate later this year."

  "Consumers continue to spend money. And they continue to earn it, with unemployment remaining low. At the same time, most foreign economies are trending higher than expected, giving our own a boost," he said.

  Chief economist Ethan Harris at Lehman Brothers said the Fed will keep taming inflation as its top priority, and that this battle is not yet over.

  "Not only is the FOMC serious about getting the core below 2 percent [annually], it does not want to declare victory on inflation prematurely," Harris said.
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