Federal Reserve Expected To Cut A Key Interest Rate

Tuesday, September 18th 2007, 10:49 am

By: News On 6

WASHINGTON (AP) _ A serious bout of financial market instability has dramatically changed the debate at the Federal Reserve from worries about inflation to concerns about the possibility of a recession.

Fed policymakers began their closed-door discussions Tuesday with investors widely expecting the central bank will decide to cut its target for the federal funds rate, the interest that banks charge each other, for the first time in more than for years.

Fed Chairman Ben Bernanke, facing his first major test since taking over from Alan Greenspan in early 2006, has been sending signals that he is prepared ``to act as needed'' to cushion the impact on the economy from the market turmoil.

A change in the funds rate, now at 5.25 percent, is reflected immediately in banks' prime lending rate, the benchmark for millions of consumer and business loans. The prime rate is currently at 8.25 percent.

Most economists are predicting that Bernanke and his colleagues will choose to reduce the federal funds rate only by a quarter point although a few economists see the chance for a bolder half-point move. But analysts agreed that whatever the Fed does on Tuesday will likely not be the last word on the subject.

Many economists are predicting a string of three or more rate cuts as the central bank works to calm financial markets and keep the worst slump in housing in 16 years from pushing the country into a recession.

``We have a very soft economy and if the Fed doesn't lower rates then the economy could fall into a recession,'' said Mark Zandi, chief economist at Economy.com.

Zandi has trimmed his forecast to show economic growth of around 2.5 percent in the current quarter, down sharply from 4 percent growth in the April-June quarter. He said the fourth quarter is likely to be even weaker at around 1.5 percent.

Analysts believe the Fed has room to cut rates because inflation pressures have been easing. In good news on that front, the Labor Department reported Tuesday that wholesale prices fell by 1.4 percent in August. It was the biggest drop in 10 months and much larger than the 0.3 percent fall that had been expected.

The slump in housing that began last year has sent delinquencies on subprime mortgages, loans make to people with weak credit histories, soaring to record levels. The problems with rising mortgage delinquencies have developed into a serious credit crunch as investors have grown worried about other types of loans, a development that has roiled stock and bond markets around the world.

All of this turmoil has forced a radical about-face at the Fed since its last meeting on Aug. 7. At that time, the Fed left the funds rate unchanged and declared that its predominant concern was still that inflation would fail to moderate as expected.

However as conditions in financial markets grew more turbulent, the Fed began aggressively pumping extra cash into the banking system and on Aug. 17 announced a surprise half-point cut in its discount rate, the interest that it charges to make direct loans to banks.

In explaining the August move, Fed officials did not mention inflation at all and instead said that ``the downside risks to growth have increase appreciably.''

Private forecasters said that worry is not misplaced, given that all but two of the housing downturns that have occurred since the end of World War II have been accompanied by recessions.

``You get as big a decline in housing as we are looking at and that is serious business,'' said Lyle Gramley, a former Fed governor and now an analyst at Stanford Financial Group in Washington. ``I think we will escape a recession, but just by the skin of our teeth.''

In one jarring note, employment fell in August by 4,000, the first outright decline in four years, with manufacturing and construction leading the job losses.

But economists said they believed that Bernanke, who wrote extensively as an economics professor on the Great Depression that followed the 1929 stock market crash, understands what needs to be done to avert downturns.

``We have had a long history of financial panics and if we have learned anything, it is that you shove money at them,'' said David Wyss, chief economist at Standard & Poor's in New York.

While some have complained that Bernanke has been more tentative than Greenspan would have been, no less an authority than Greenspan disagrees.

Doing a round of interviews to promote his new book, Greenspan, who was Fed chairman for 18 1/2 years, said Bernanke was ``doing an excellent job'' and he doubted that he would have done anything differently.

Greenspan told The Associated Press that the odds of a recession have grown since earlier this year, even though ``the economy is not doing badly at this stage.''

He put the odds of a recession at greater than one in three. ``But best I can judge it is less than 50 percent,'' he said.

Greenspan's one-in-three prediction earlier this year rocked Wall Street.