Fed May Cut Rate to 1%, Signal Steps to Save Economy

By Steve Matthews

Oct. 29 (Bloomberg) -- The Federal Reserve may lower its benchmark interest rate to 1 percent today and signal further reductions to levels unseen since Dwight Eisenhower was president.

Tumbling commodities prices and weaker consumer spending are slowing inflation, which officials described as a ``significant concern'' at their last scheduled meeting in September. Tomorrow, the Commerce Department will probably report that the economy shrank at a 0.5 percent annual rate in the third quarter, the most since the 2001 recession, economists predict.

The Fed ``will be very aggressive,'' said Mark Gertler, a New York University economist and research co-author with Fed Chairman Ben S. Bernanke. ``Inflation risks are off the table'' and ``the issue now is how bad the recession will be.''

He predicted the benchmark rate will be cut by half a point today, matching the median forecast of economists surveyed by Bloomberg News. Bernanke and his team could push borrowing costs to zero by June if the credit crunch intensifies, Gertler said.

The Fed has already cut the benchmark rate from 5.25 percent in the past 13 months and created six lending programs channeling more than $1 trillion into the financial system. Banks are still reluctant to lend to each other and the Standard & Poor's 500 Index is down almost 36 percent this year, even after yesterday's surge.

The FOMC is scheduled to announce its decision on rates at about 2:15 p.m. in Washington.

`Inadequate Growth'

``The predominant concern will be inadequate growth,'' said former Fed Governor Lyle Gramley, now a Washington-based senior economic adviser for Stanford Group Co., a wealth-management firm. ``If the economy shows additional signs of a deepening recession, I think the Fed will decide that the floor is not 1 percent.''

Gramley predicts that policy makers will again cut the main rate by 0.5 percentage point at their next scheduled meeting in December, pushing it toward levels last seen in 1958. ``Zero is a possibility,'' he said.

The dollar fell for a second day against the euro on bets the Fed will lower interest rates more than economists predict. Futures on the Chicago Board of Trade show a 38 percent chance the benchmark rate will be cut to 0.75 percent from 1.5 percent. The odds increased from 34 percent a day before.

`Weakening Demand'

European Central Bank President Jean-Claude Trichet said Oct. 27 he may reduce interest rates next week, citing ebbing inflation and ``weakening demand.'' The ECB, Fed and four other central banks trimmed rates by a half point on Oct. 8 in an unprecedented coordinated move.

After the emergency cut, the Fed signaled it may ease again, citing ``weakening of economic activity and a reduction in inflationary pressures.''

Most of the FOMC's statement today will focus on the financial crisis, including tightening credit conditions, said Robert Eisenbeis, a former Atlanta Fed economist.

The statement will also note falling energy prices and express ``less concern, as a result, about inflation,'' said Eisenbeis, chief monetary economist at hedge fund Cumberland Advisors Inc. in Vineland, New Jersey. Beginning today the central bank will probably cut in 0.50 percentage-point increments, stopping at 0.25 percent, he said.

Fed policy makers face increasing evidence the economy is already in a recession. Consumer confidence plunged this month, with the Conference Board's confidence index hitting its lowest level since records began in 1967.

Longest Slump

Payrolls fell last month by 159,000 for the biggest reduction in five years, according to Labor Department figures released on Oct. 3. Retail sales fell 1.2 percent in September, extending their decline to a third consecutive month for the longest slump in at least 16 years.

``Sharply increasing unemployment'' and other data indicate ``the probability has gone up substantially'' that the U.S. economy will begin to shrink, St. Louis Fed President James Bullard said Oct. 14.

The Fed cut the main rate to 1 percent in June 2003, leaving it unchanged for a year in response to concerns about deflation. Bullard and Dallas Fed President Richard Fisher have said the low rate stoked inflationary pressures.

Rising prices have faded as a concern in recent months. Americans expect inflation of 2.8 percent over the next five years, the slowest pace in a year, according to the Reuters/University of Michigan preliminary index of consumer sentiment on Oct. 17.

Global Recession

Crude oil fell to a 17-month low on Oct. 27 amid heightened concern that a global recession will erode consumption. The price of oil has tumbled 56 percent since reaching a record $147.27 on July 11.

With inflation abating, the FOMC may vote with no dissents. Fisher supported the last rate reduction after dissenting as recently as Aug. 5 out of concern about rising prices.

``With the deterioration in economic conditions and the recent associated falloff in energy and many other commodity prices, I anticipate further dissipation of inflationary pressures,'' Atlanta Fed President Dennis Lockhart said Oct. 20.

Cutting rates too far may hurt the money market mutual fund industry by making it difficult for the funds to attract deposits profitably, said Vincent Reinhart, the Fed's chief monetary-policy strategist from 2001 until September 2007.

``As the policy rate goes closer toward zero, rates get compressed and those business models are called into question,'' he said. If that concern is dispelled, the main rate ``could go to 1 percent'' while policy makers say risks are ``tilted toward economic weakness,'' indicating they may further pare rates.

To contact the reporter on this story: Steve Matthews in Atlanta at smatthews@bloomberg.net.