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Fed seen cutting US interest rates half-point Tues

Fed seen cutting US interest rates half-point Tues

The Federal Reserve meets on Tuesday amid widespread expectations it will aggressively cut U.S. interest rates by a half-percentage point for the fifth time this year to lift the shaky economy on to solid ground.

But analysts said such a move by the U.S. central bank this week may be the last large cut for some time as its policy-makers step back and watch how their rate-cutting campaign will impact the world's richest economy.

"I think they've got to at some point say 'now we're going to wait for our previous rate actions to hit the market, to have an impact on real activity'," Brown Brothers Harriman senior economist Lara Rhame said.

"There is a limit to where the Fed can go," she said. "There is a limit and I think we're close to that."

Responding to a dramatic slowdown in the U.S. economy, the central bank has cut interest rates by 2 percentage points this year, bringing the federal funds rate - the key interest rate that influences the cost of borrowing money for everything from cars to refrigerators - to 4.5 percent.

If the Fed cuts interest rates by another half-percentage point on Tuesday, the federal funds rate will hit its lowest level in seven years.

There is little doubt the Fed will do just that. In a Reuters poll taken on Friday, all but one of the 25 primary dealers of government securities, firms that trade directly with the Fed in money markets, said they expected a half-point cut on Tuesday. One firm predicted a quarter-point cut.

The Fed is expected to announce the outcome of its meeting at around 2:15 p.m. (1815 GMT) on Tuesday.

WAIT AND SEE

Analysts said the main factor that will prompt the Fed to go for the more aggressive half-point cut is the deteriorating employment situation.

Earlier this month, the government reported that U.S. payroll employment excluding the farm sector plunged 223,000 in April after 53,000 job losses in March. The unemployment rate rose to 4.5 percent from 4.3 percent, bringing it to its highest level in 2-1/2 years.

But other indicators have suggested that the Fed's moves to bolster the economy may be working.

The Commerce Department reported on Friday that sales at retail stores grew a hefty 0.8 percent last month after falling in February and March. The report suggested consumers may be reopening their wallets, a key move since consumer spending accounts for two-thirds of U.S. economic activity.

And according to government statistics, the economy grew at a 2 percent annual rate in the first three months of this year, doubling the 1 percent measured in the final quarter of 2000. The report suggested the U.S. economy was not heading into a recession as many had feared. A recession is commonly described as two straight quarters of contraction.

The positive news has led some analysts to think that after Tuesday, the Fed may pause. It is widely believed that Fed moves operate with a lag, so central bankers may want to wait a while to see if they have done enough.

"This may be the last for a while," Economics from Washington president Douglas Lee said.

INFLATION?

Lee said part of the reason the Fed may pause is there have been some signs that inflation may be rising. If the Fed cuts rates too far, they will have a tougher time fighting inflation, which usually requires an increase in rates.

"There is some growing concern that we may have a little bit more of an inflation problem than people expected," Lee said. "I don't think the Fed wants to turn around and raise interest rates fairly soon."

Some analysts said they expected the Fed to temper the language in the statement it issues after the meeting. They expected the statement to soften expectations for future aggressive rate cuts so investors, who have become accustomed to a steady stream of Fed moves, will not be disappointed if the central bank sits on the sidelines.

Many expect the Fed will ditch the wording that it will "monitor" the economy "closely," which appeared in the statements following the March 20 and December 19 meetings.

That wording was seen as a signal the Fed was poised to take the rare step of cutting rates in between regular meetings, which it did within weeks after both those statements were released.

"The one thing I don't think they will put in there is this language about monitoring closely," PNC financial services group chief economist Stuart Hoffman said.

After Tuesday, the Fed next meets on June 26 and 27. Of the 25 primary dealers polled by Reuters on Friday, 18 said they expected another rate cut in June while five predicted the Fed will keep rates steady and two declined to make a call.


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