Fed Signals Door `Open’ for Cutting Rates to Lowest on Record

Oct. 30 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke signaled he’s ready to cut interest rates to the lowest level on record should the central bank’s actions fail to stem the deepening economic slump.

Policy makers said yesterday that “downside risks to growth remain” even after their half-point reduction in the main rate to 1 percent. The Fed dropped a reference in its statement to threats from inflation, projecting “levels consistent with price stability” in coming quarters.

“The door is wide open for further rate cuts or anything else that might help the economy,” said Allen Sinai, chief economist at Decision Economics in New York. “The implication is that we’ll see another half-point cut in December, if the prospects for the economy remain poor.”

Bernanke is drawing on an academic career studying the failed efforts to prevent the Great Depression, and yesterday’s shift indicates he’s prepared to revisit his 2003 commitment as a governor to lower rates to zero percent if necessary. Should lending fail to revive by December, the central bank will probably cut by another half point, said former Fed Governor Lyle Gramley.

“There is no doubt that the principal risk today is a downside risk” to growth, said Gramley, who is now a Washington-based senior economic adviser for Stanford Group Co., a wealth-management firm. “Inflation has been taken off the table.”

Global Impact

Reflecting a crisis that has reverberated throughout the global economy, the Fed’s Open Market Committee yesterday said that international rate cuts should contribute by loosening credit markets. The FOMC also said slowing economies abroad will threaten the record boom in American exports, which have kept the U.S. from a deeper slump.

“Both of these references show the global nature of the current situation and the global coordinated response, which is the mindset best suited for today’s crisis and the crises of tomorrow,” Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. LLC in New York, wrote in a note.

In a new step to increase the availability of dollars in emerging markets, the Fed yesterday agreed to provide $120 billion to four counterparts. Brazil, Mexico, South Korea and Singapore get $30 billion each by signing the so-called currency swap lines. The U.S. already has unlimited agreements with the European Central Bank and Bank of England.

Pumping Cash

The swap lines are on top of six domestic loan programs created over the past year that channeled at least $700 billion in cash and collateral into money markets as of Oct. 22.

The FOMC has now lowered its target for the overnight lending rate between banks by 4.25 percentage points since September 2007. The federal funds rate averaged 0.68 percent in July 1958. The Fed began using the rate as its main policy tool in the late 1980s.

Bernanke was the leading Fed governor spearheading research into non-traditional monetary tools between 2002 and 2004, the last period when the central bank lowered the target to 1 percent. Traders nicknamed him “Helicopter Ben” after a November 2002 speech that referenced Milton Friedman‘s comments comparing such unorthodox methods to dropping money from a helicopter.

Policy makers’ next steps depend on whether the financial system begins to function and channel credit to consumers and businesses, Fed-watchers said.

The risk is that several quarters of economic deterioration, with soaring unemployment and falling consumer spending, will stop banks from ramping up new lending.

Shrinking Economy

The Commerce Department may report today that the economy contracted at a 0.5 percent annualized pace in the third quarter, according to the median forecast in a Bloomberg News survey. Analysts at Morgan Stanley see a contraction of about 3.5 percent in the October to December period, with their Deutsche Bank AG counterparts anticipating a 4.5 percent decline.

“There is a decent chance they end up going lower because of the economic weakness in train,” said Brian Sack, vice president at Macroeconomic Advisers LLC in Washington and a former Fed researcher. Fed officials could keep cutting to zero and then switch to unconventional policies. Or they could switch to those tools even before a zero interest rate.

Bernanke said in 2003 that a non-traditional policy campaign would involve a commitment to keep the federal funds rate low for an “extended period,” purchases of bonds to keep down market-set rates and an “announced program of oversupplying bank reserves.”

Bank Reserves

Bank reserves are already in surplus. So-called excess reserves, or the cash held above the level required to protect depositors, more than doubled to $282 billion for the two weeks ending Oct. 22.

The Fed may hold off on raising rates until 2010, said John Ryding, founder and chief economist of RDQ Economics LLC in New York.

“The Fed has never made its first rate hike after a recession until the unemployment rate has peaked, and I’m not about to start predicting they’re going to change behaviors now,” Ryding said. The median forecast of economists in a Bloomberg survey is for the jobless rate to climb to 6.8 percent by June from last month’s 6.1 percent.

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