By John Cranford
Washington, June 25 (Bloomberg) -- No matter how much Federal Reserve policy makers lower interest rates this week, they are likely to signal that additional reductions are possible because the economy shows few signs of responding to the medicine they've handed out so far.
The slump in manufacturing has deepened, as the latest figures on industrial production showed. And business investment in equipment and software may show a third straight decline in the second quarter, the first time that's happened in 18 years.
``The Fed just has to keep pushing until there are clear signs that interest-sensitive sectors are starting to pick up,'' said Steven Wood, chief economist at FinancialOxygen Inc. in Walnut Creek, California.
The overnight bank lending rate is now 4 percent, the lowest in seven years. If the Fed reduces it by a half percentage point on Wednesday, as Wood and many economists expect, it would be the sixth such reduction this year. If central bankers only cut a quarter point, as many other analysts forecast, this year would still mark the most aggressive round of reductions in 19 years.
Policy makers will probably leave the impression they aren't done unless there is a marked improvement.
``It's premature to conclude the Fed is slowing it down,'' said Jim Glassman, senior economist J.P. Morgan Securities in New York. Inflation isn't now a threat, the latest consumer price report showed. So, ``there's little risk that the Fed will go overboard,'' he said.
Growth Stalled
The economy slowed from a 5.6 percent rate of growth in the second quarter of last year to a 1 percent pace in the final three months of the year. The period from October through March marked the weakest six months in almost 10 years. The Fed's own report card on the economy, the beige book, said last week that growth had stalled in April and May.
Still, while there's almost no debate about whether the Fed will cut rates at its Wednesday meeting, investors and analysts are almost evenly divided over how large the reduction will be. An increasing number of economists over the past week said they expected a half-point cut.
``Economic data continue to deteriorate,'' said Bruce Steinberg, chief economist at Merrill Lynch & Co., explaining in a report why his firm had raised its forecast. ``We think the Fed will need to try to get ahead of this again.''
Of 54 economists surveyed by Bloomberg News, 30 are forecasting a quarter-point reduction and 24 a half-point cut.
Trading in federal funds futures contracts for July, tied directly to the Fed's meeting, shows investors about evenly split.
Business, Consumer Spending
For the Fed's policy-setting Open Market Committee, there are several concerns going into the meeting.
Business investment is showing no signs of picking up. While consumer spending hasn't wavered much, it might falter if unemployment rises above the current 4.4 percent rate. When the economy does rebound -- whether late this year or in 2002 -- the demand generated by falling interest rates and the Bush administration's tax cut might be so strong that inflation once again becomes a threat. The Fed then would probably decide it needed to take back some of this year's rate cuts.
Analysts said it's difficult to weigh those concerns. ``There's a lot of division about what they should be doing,'' said Diane Swonk, chief economist at Bank One Corp., who expects a quarter-point cut.
Rising Productivity
For two years, Fed Chairman Alan Greenspan has touted the benefits of business investment in computers, telecommunications and other innovations, saying it has caused an acceleration of worker productivity that shows no signs of receding. With factories using just 76 percent of their capacity in May -- an 18- year low -- Greenspan may be concerned that future investment and future productivity gains are in doubt.
``Company news has been pretty bleak,'' said Stuart Hoffman, chief economist at PNC Bank in Pittsburgh. ``There's got to be growing concern about how deep the slump in business investment is and how long it lasts,'' said Hoffman, who's looking for a half- point.
Makers of computers, chips and electronic components reduced worker hours in May to keep stockpiles in line with receding demand. The computer market ``has gone from slow growth to no growth quite quickly,'' said Anne Mulcahy, president of Xerox Corp., on June 14. ``It would be fair to say we're not counting on a turnaround of the economy to deliver our expectations.''
In a statement following its May 15 rate cut, the Fed highlighted this issue. ``The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward,'' the Fed said.
Encouraging Investment
Spending on equipment and software fell at a 3.3 percent annual rate in the fourth quarter and a 2.6 percent pace in the first. And there's no sign that lower rates have encouraged businesses to invest.
Factory shipments of non-defense capital goods, excluding aircraft, fell 3.4 percent in April. New orders for goods in this category, which is watched by economists and Fed officials as a proxy for business investment, have declined in six of the last seven months.
Moreover, business borrowing has declined at a 10 percent rate over the last three months, said Chris Low, chief economist at First Tennessee Capital Markets in New York. That's because many companies still have stockpiles of unsold goods, Low said. ``Until they work through those excess inventories, there's no reason to borrow,'' Low said.
Fed Comments
Analysts seeking hints from Fed officials about how deep a rate cut to expect can find support for all views.
Fed Vice Chairman Roger Ferguson was most explicit in stating his concern that some investors seem to be too eager for a quick rebound. ``I personally think it's a bit too early to anticipate a recovery,'' he said June 14.
And Richmond Fed Bank President Al Broaddus said June 18 that ``it's far from clear at this point that the economy is bottoming out, and if it continues to weaken, additional stimulus may well be needed.''
At the same time, ``we have a situation where people have to be getting a little antsy about their jobs,'' said New York Fed Bank President William McDonough on June 12. That poses a threat to continued consumer spending, he said.
While some analysts took those remarks as a sign a larger cut is likely, others see signs that the Fed might reduce just a quarter-point to preserve its ammunition.
Even if lower rates aren't pushing businesses to invest, ``the Fed is reaching consumers,'' said Low. ``It's all psychology.'' A series of quarter-point reductions over several months may keep consumers happy and give businesses more time to get back on their feet, he said.