Fed ‘Caught Off Guard’

Fed ‘Caught Off Guard’ By Rate Of Us Slowdown

By Suzy Jagger, NY, LondonTimes | 3 January 2008

The scale of the housing slump across the United States and the speed at which the American economy has slowed has caught the US Federal Reserve off guard, minutes from the world’s biggest central bank suggested yesterday. The minutes of the December 11 meeting of the Fed’s interest-rate-setting committee— after which the central bank cut interest rates by a quarter of a percentage point— indicated that a sharper reduction of interest rates was more likely as credit markets continued to dry up.

The Fed also pointed out that turmoil in the credit markets during the summer had spilled over to hit consumer spending, a key driver of growth in the United States, and showed that officials had been caught off guard by the extent of the housing slump. "Participants agreed that the housing correction was likely to be both deeper and more prolonged than they had anticipated in October," the minutes said. The increasingly uncertain outlook for the world’s largest economy triggered a surge in demand for safe-haven assets, such as gold and platinum. The price of gold jumped to its highest ever level, at $861.80 an ounce, before closing at $857.40, a rise of $23.40 on the day, while platinum rose $11.00 to $1,544.00.

Adding to the gloom, the price of oil hit an all-time record, breaching $100 a barrel amid diminishing stockpiles and increasing violence in the oil-producing Niger Delta in Nigeria. Anxieties about the increasing likelihood of a sharp slowdown for the economy triggered a slide on the Dow Jones industrial average, the leading Wall Street index, which closed down 220.80 points at 13,044.00 yesterday. The Fed, which has cut rates by 1 percentage point since September, has to balance the need to avert the US sliding into recession with the risk that cheaper borrowing costs will stimulate inflation.

At the December meeting of the Fed’s Open Markets Committee, nine bankers voted in favour of a quarter-point rate cut, with only one dissenter, Eric Rosengren, the president of the Boston Federal Reserve Bank, who wanted a half-percentage-point cut. The quarter-point cut to 4.25 per cent represented the third reduction in the cost of borrowing since September. At the same time, the Fed also lowered the discount rate that it charges banks that borrow directly from it by one quarter of a percentage point, to 4.75 per cent.

Jennifer Lee, an economist at BMO Capital Markets, said that the Fed, under its Chairman Ben Bernanke, seemed to be struck by "the fact that economic activity and financial market deterioration seemed to be occurring at a faster pace than members anticipated, particularly after the October 30-31 meeting". December’s rate cut came one day before the Fed launched a bid with other central banks to ease the credit crisis by coordinating capital injections into the markets. Three days after the cut, data showed a jump in consumer price inflation, which could limit the central banks' willingness to provide further monetary stimulus.

Related Links:
National City to cut 800 jobs and halve dividend
Another rate cut imminent as new orders slump
Economist says US could plunge into recession