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Reuters Business Report

Fed May Concede Economy Risks, Hold Rates

By Victoria Thieberger

NEW YORK (Reuters) - The U.S. economic recovery has stumbled during the summer, but it is not yet time for the Federal Reserve to administer smelling salts, economists say.

Although calls on Wall Street for another interest rate cut have grown louder in the past week after a run of soft data, most primary dealers who trade directly with the Fed do not believe there is enough evidence yet for a cut, a Reuters poll found on Wednesday.

But the central bank could say that the economic risks are tilted more toward weakness than inflation at its policy meeting next Tuesday, which would be the first hint that it may consider lowering interest rates in coming months.

The Reuters survey found 17 of 21 dealers say the Federal Reserve will hold rates at a low 1.75 percent through the end of this year and well into next year, a big change from just a few weeks ago. Then, nine predicted the central bank would raise rates by the end of the year.

Four houses now expect lower interest rates by the end of the year, up from two in a similar survey taken last Friday.

"The key difference now is you're starting to see some damage show up in the real side of the economy" from the stock market slide, said Lehman Brothers senior economist Joseph Abate. He cited weaker durable goods orders, payrolls and manufacturing.

"The other factor too is that the credit markets are freezing up. There's a growing sense of anxiety about the credit-worthiness of borrowers," and that can take its toll on economic activity, Abate added. Lehman this week made an aggressive forecast of three rate cuts by year's end, to 1.0 percent.

The federal funds rate stands at a four-decade low of 1.75 percent after a series of 11 rate cuts last year.

A SHIFT IN RISKS?

Consumer spending has moderated, but Americans are still taking advantage of low interest rates to snap up new cars and houses. The worries are that the persistent stock market declines will wear out consumers and force businesses to postpone investment that is key to reviving the economy.

In Wednesday's survey, primary dealers raised the chances the Federal Reserve will cut borrowing costs for businesses and consumers some time this year to 42 percent, up from 36 percent last week.

The first indication of concern from the Fed could come in the statement it releases after Tuesday's regular meeting of the Federal Open Market Committee, which sets monetary policy.

Since March, the Fed has said the risks to the economy were balanced between weakness and inflation. But a growing number of analysts believe it is time for the Fed to acknowledge the risks have shifted toward weaker growth.

"Changing the risks would tell the market the Fed doesn't have its head in the sand," said Avery Shenfeld, senior economist at CIBC World Markets in Toronto.

The Reuters survey found seven dealers believe the Fed's stance will lean toward weakness, a big jump from three dealers last Friday.

Those who expect no change in the balance of risks cite the danger of spooking financial markets by acknowledging a softer outlook while taking no action.

The most recent commentary from senior Fed officials, after the disappointing July payrolls report last Friday, suggested no inclination to ease. Just last month, Fed economists upgraded their growth forecasts, though those estimates look a tad optimistic now.

San Francisco Federal Reserve President Robert Parry said on Friday the recovery was still intact and not under serious threat. St. Louis Fed President William Poole said on Sunday he saw a "very, very small" risk the economy will fall back into recession, given the stock market's slide.

Treasury bond yields have fallen sharply in recent weeks as traders ramped up expectations of another easing.

But economists say there is not enough evidence that the modest recovery is faltering to justify that yet.

"We have really gotten only two weeks' or one month's statistics, which is not the creation of a trend," said BNP Paribas chief economist Brian Fabbri.

"Frankly, the Fed needs more evidence, at least another month or so, to make a change in policy."

http://biz.yahoo.com/rb/020807/economy_fed_poll_2.html