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Fed Leaves Markets Divided Over Further Rate Cuts

CNBC.com With Wires
Wednesday, 30 Apr 2008 | 2:17 PM ET

The Federal Reserve trimmed interest rates another quarter point, to 2%, as expected, but left markets guessing about whether further cuts would be needed.

The Fed action, after a two-day meeting, pushed benchmark short-term interest rates down to the lowest level since late 2004.

It also marked the seventh consecutive rate cut by the central bank since it began easing credit conditions last September to combat the growing threat of a recession brought on by a deep housing slump and credit crisis.

Ben Bernanke
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Ben Bernanke

The rate cut will mean lower borrowing costs throughout the economy as banks reduce their prime lending rate, the benchmark for millions of consumer and business loans.

Though the Fed move was expected, the accompanying statement left Wall Street puzzled about where the central bank goes from here.

Wall Street had been hoping that this could well wrap up the Fed's rate cuts unless the economy falls into a worse slump than currently expected. And some viewed the statement as signaling a pause.

"I do think they moved to a neutral type of statement," Bill Gross, head of PIMCO, the world's biggest bond fund, said on CNBC shortly after the Fed announcement. "I think 2% is where we're going to be for perhaps a long, long time."

But others seemed to think that the central bank was leaving the door open to further rate cuts. The confusion was clearly evident in the markets.

Stocks initially moved higher after the Fed announcement but then reversed course and closed lower.

The dollar also rallied initially but then fell as traders concluded that the Fed was still likely to cut again. Lower interest rates make dollar-denominated investments less attractive.

"Understanding this statement is a lot like reading the Bible and trying to understand it," said Robert Brusca, chief economist at Fact And Opinion Economics, in a note to clients. "The verbiage remains cloudy but that the Fed stands ready is clear."

In its statement, the Fed said it stood ready to "act as needed to promote sustainable economic growth and stability." That phrase was seen as a signal that the Fed is as worried about weak growth as it is about the risk of higher inflation.

The central bank pointed to the "substantial" reductions it has already put in place and noted that energy and other commodity prices were on the rise.

It also dropped a reference contained in its last interest-rate announcement that "downside risks to growth remain."

"The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity," the central bank said.

While the Fed said uncertainty on the outlook for prices remained high, it also said it still believed inflation would moderate over time, which some analysts saw as suggesting the possibility rates could move lower.

"This statement strongly implies that the Fed will be on pause for some time," said Joseph Brusuelas, U.S. chief economist at IDEAglobal in New York. "The risks to the upside vis-a-vis inflation are serious enough to be on hold until the lagged impact of past Fed monetary policy and the fiscal stimulus on its way take hold."

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The Fed devoted portions of its statement to both the threats of weakness and the threats that inflation could pose, likely reflecting the debate inside the central bank.

There were two dissents from the move, with both Richard Fisher, president of the Dallas regional Fed bank, and Charles Plosser, head of the Philadelphia Fed, arguing that the central bank should make no change in rates.

The central bank is walking a tightrope, trying to jump-start economic growth while also confronting the risk that if it overdoes the credit easing it could make inflation worse down the road.

Many economists believe the country has fallen into a recession.

Fed policy-makers gathered shortly after the government said the economy grew at a sluggish 0.6 percent annual rate in the first quarter, a slightly stronger-than-expected pace, as inventory-building tempered a deteriorating housing market and softer consumer spending.

Another report showed U.S. private sector employers unexpectedly added 10,000 jobs in April, suggesting the economy retained some resilience "The key here is that a pullback is more shallow than expected," said Marc Pado, a U.S. market strategist at Cantor Fitzgerald in San Francisco.

Fed policy-makers have been confronting a bleak landscape. The U.S. housing market has shown no sign of hitting bottom and credit markets still appear strained.

At the same, elevated prices for food and fuel are causing concerns among both consumers and Fed officials.

In addition to lowering rates to spur the economy, the central bank has rolled out a series of emergency steps to pump billions of dollars of liquidity into financial markets to beat back a credit crunch.

While Wednesday's GDP report was more robust than expected, details reflected widespread weakening in the economy.

Consumer spending, which accounts for about two-thirds of U.S. output, grew at the weakest rate since the second quarter of 2001, the last time the economy was in recession.

Housing continued its dizzying nosedive, with spending on residential construction recording the biggest drop in more than 26 years and its ninth consecutive quarterly contraction.

At the same time, with gasoline prices heading toward $4 a gallon and strong global demand pushing up food prices, some Fed officials have worried openly that a desire to support the economy could lead the central bank to take its eyes off inflation.

The Fed's rate cuts have led to a weakening in the U.S. dollar that has pushed import prices higher, adding to inflation pressures.

But Fed officials believe unemployment is likely to climb amid the economy's weakness, making it difficult for businesses to raise their prices, a view that may gain greater sway after the GDP report.

"Current conditions of the production side of the economy are not generating inflation," said Pierre Ellis, an economist with Decision Economics in New York.

Policy-makers also expect the combined effects of the central bank's rate cuts -- which act with a lag -- and a $152 billion fiscal stimulus package will provide a boost to the economy in months to come.

--Reuters and AP contributed to this report.

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