--- by Greg Robb ----
WASHINGTON (AFX) - The Federal Open Market Committee is likely to cut rates by 50 basis points to 3.5 pct at its meeting on Wednesday rather than by the previously expected 25 points given that recent data has shown the economy to be almost at a standstill, economists said. Until mid-June, the general consensus had been for a 25 basis point cut but now it seems that the FOMC still has work to do to finish the job it started in January -- fight off a recession.
"The economy is still very close to the edge of recession," said Lyle Gramley, a former Federal Reserve board governor, who now expects a 50 basis point rate cut.
William Dudley, chief economist at Goldman Sachs, agreed. "We're not quite in a recession but it is pretty close. The Fed is basically trying to prevent it and that is why in our view they will cut by 50 basis points."
Gramley said that until May industrial production data was released on June 15, he had been forecasting a 25 basis point rate cut, but the figures showed a widespread weakness warranting a change to 50 basis points.
"The manufacturing sector is plummeting deeper (into) recession and this could very well spill over" into the wider economy," Gramley said.
Geoffrey Somes, senior economist at FleetBoston Financial, told his clients this week that the language of the latest Fed Beige Book report on current economic activity came close to the official definition of a recession.
On the other hand, many economists still believe the FOMC will cut by a more moderate 25 basis points on the basis that the economy is poised for a recovery and any larger FOMC rate reduction would have to be quickly taken back in the next few quarters to keep inflation in check.
"I don't think the second half of 2001 and the first half of 2002 are going to be (very strong) but the odds are favouring a pick up," said Paul Kasriel, chief U.S. economist at Northern Trust Co in Chicago.
Ken Goldstein, economist at the Conference Board agreed, saying that "everything is in place for a turnaround".
Goldstein even suggested the FOMC might hold rates steady to gauge whether the weakness was continuing.
Kasreil of Northern Trust said that the Fed has a looming inflation problem on its hands, whether Fed chairman Alan Greenspan admits it or not.
"Maybe he (Greenspan) is not concerned about inflation but the inflation rate has been trending higher and taking energy out (of the data) doesn't change the story," Kasreil said.
However, those analysts in the 50 basis point camp discount the possibility of inflation given their view that the economy is going to see only a slow recovery.
"It depends on how fast you think the economy is going to snap back," Dudley said.
"The Fed has to worry more about the possibility that we will slip into recession than that 50 basis points is going to create inflation later on," Gramley said.
The FOMC has already cut rates by 250 basis points since Jan 3 but many economists think that the economy has not benefited yet from the traditional impact of monetary easing.
"The Fed is not getting the normal (response) from monetary policy," Dudley said.
Typically, the stockmarket rises, and bond yields and the exchange rates fall as rates are cut but, since the start of the easing in January, "the stockmarket hasn't gone up, bond market yields haven't fallen and the dollar has appreciated," Dudley said.
Economists also noted that they have been able to glean very little from recent speeches or comments by Fed officials, including those by Greenspan on May 24 or in Congressional testimony last week. In his May 24 speech, his first public discussion of the economy since February, Greenspan said "the period of sub-par economic growth is not yet over and we are not free of the risk that economic weakness will be greater than currently anticipated, requiring a further policy response."
But he went on to add that the Fed "also needs to be aware that our front-loaded policy actions this year should be providing substantial support for a strengthening of economic activity later this year." Greenspan "could have directed people" to the size of the FOMC move on June 27 but chose not to, Dudley said, calling Greenspan's much anticipated speech the "dog who didn't bark".
Based on speeches and comments from Fed officials since the last meeting on May 15, "our sense is Greenspan is inclined to do 50 (basis points) and other people on the federal reserve are probably more inclined to slow down to 25," Dudley said.
Mike Moran, chief economist at Daiwa Securities America Inc, said be believes "several Fed officials will advance compelling arguments for a policy change of only 25 basis points at the upcoming FOMC meeting but the arguments in favour of another bold move will be convincing as well.
"In the end we suspect that policy makers will prefer to err on the side of accommodation and approve a shift of 50 basis points." Maury Harris of UBS Warburg put the odds of a 50 basis point move at 60 pct.
On the bigger question of how low rates will go in the current easing cycle, most economists believe the FOMC will hold at 3.5 pct for some time.
However, Ian Morris, chief economist at HSBC Securities, said he now expects Fed funds to fall to just 2.75 pct by year-end. Morris said the cut would likely be 25 basis points this week but a written statement would signal that the Fed is prepared to make a third inter-meeting rate cut this year.
"I think there is good chance of an inter-meeting cut. I expect the statement to say something like 'we'll continue to monitor the evolving situation', which has become the code for inter-meeting cut possibilities," Morris said.