21 August 2001, 08:17  FED OUTLOOK: 25-bp rate cut seen Tuesday, more possible by

By Edward Kean
Washington, Aug. 20 (BridgeNews) - The Federal Reserve will trim its key short-term interest rate target one-quarter percentage point Tuesday in a further attempt by the central bank to energize the listless U.S. economy, analysts predicted. Moreover, some economists said Tuesday's rate cut may not be the last such reduction this year by the Fed.
Although the economy has shown some signs of bottoming out, analysts said there is not yet enough compelling evidence of better times to let the Fed retreat to the sidelines. Moreover, inflation pressures have receded, allowing the Fed to lower rates even further to help enliven activity, economists say.
"The economy remains very much at risk to the downside and the inflation news has improved, so the consequences of easing too much would not be too unfavorable at this point," Goldman Sachs research director William Dudley wrote.
In contrast to the Fed's policy meetings in May and June, when there was uncertainty over how much the Fed would cut rates, there is virtually no suspense regarding the outcome of Tuesday's meeting. Nearly all economists surveyed agreed that a one-quarter point cut is probable this week. Also, economists agreed the Fed is likely to state that economic weakness, not inflation, remains the primary threat.
The Fed has cut its key federal funds target six times this year by a combined 2.75 percentage points to 3.75%. But the economy has remained weaker than many economists anticipated. Nevertheless, economists said they expected growth to strengthen later this year from the effects of the Fed's prior rate reductions, lower energy prices, and the tax rebate checks now being sent to taxpayers.
Analysts said it is highly unlikely that the Fed would return this week to a more aggressive rate cut of one-half percentage point, especially when there have been hints of stabilization in economic data, such as manufacturing activity and initial unemployment insurance claims. Earlier this year, the Fed cut rates by one-half point on five separate occasions. But it announced in June that it was scaling back its monetary stimulus by cutting rates only one-quarter point. Some Fed officials have expressed concern that if the Fed cuts rates too much now, it will lead to higher inflation in the future.
"I interpret the recent economic numbers as providing pretty solid confirmation the economy is bottoming out," said former Fed Gov. Lyle Gramley, now a consulting economist with the Mortgage Bankers Association. In that situation, the Fed is unlikely to revert to a larger rate cut, he said.
"I think the economic data are mixed enough to suggest the economy is not deteriorating much further than a month ago," said Sal Guatieri, senior economist for the Bank of Montreal. "It seems to have stalled, but it's not getting worse. Until there is evidence the economy is worsening, I don't think the Fed will shift back to aggressive rate cutting of 50 basis points."
While economists agree on what is likely to occur at Tuesday's Fed meeting, they are quite divided on whether Tuesday's rate cut will be the last for 2001.
Several economists said the Fed's rate reduction Tuesday could be the final one this year and the Fed's economic-stimulus campaign is nearly over.
Gramley said chances of an economic improvement have risen and said he suspected the Fed may be able to keep rates steady in October. "I think they are getting toward the end of the road," said Joshua Feinman, of Deutsche Asset Management, who noted the Fed already had "put in a lot of stimulus."
But other economists are convinced the Fed will have to drop rates further after this week's action.
"We don't think it will be the last of the rate cuts we see this year," said David Resler, of Nomura Securities. "We think there will be at least 50 basis points more of rate cuts this year."
Although the economy is likely to show stronger growth in the third quarter, Resler said that improvement would be the result of temporary factors, and growth would slip in the fourth quarter. Overall, Resler said the economy will be stuck in a sluggish 1-2% growth path until the middle of next year.
Rory Robertson, an interest rate strategist for Macquarie Equities, said if the Fed cuts rates by one-quarter point Tuesday, it will be "under pressure" to ease again in October. More weakness in employment is likely and it will be hard for the Fed to stop easing until employment stops falling, said Robertson.
He said he expected the Fed would cut rates another 75 basis points by year-end.
Whether the Fed needs to ease again will depend largely on the extent to which individuals spend their tax rebate checks, Banc One Investment Advisors chief economist Anthony Chan said. If consumers spend 50% or more of their rebate checks, the Fed may be able to put off further rate cuts, he said.
Even if the Fed is able to keep rates on hold at its October meeting, the Fed is unlikely to switch anytime soon to a "neutral" view of the economic risks, in which it says inflation is as great a threat as economic weakness.
"It's way too early for them to do that," Chan said.
The Fed would need to see "some stability in the manufacturing sector and signs of acceleration in consumer spending" to switch to a balanced view of the risks, said Banc of America Securities economist Peter Kretzmer.

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