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Behind latest Fed rate cut, inflation fears loom

The Straits Times – March 20, 2008

WASHINGTON – THE United States central bank cut interest rates by three-quarters of a percentage point to 2.25 per cent, less than widely expected but more than what some of its policymakers were comfortable with.

Two of the 10 voting members of the Federal Open Market Committee opposed the cut, preferring ‘less aggressive action’, according to the Federal Reserve’s statement on Tuesday. Markets had expected a bigger 1 percentage point cut.

It was the first time since September 2002 that a pair of policymakers defied their Fed colleagues, and analysts sensed a change in the central bank’s message.

‘The message was, we’re going to be vigilant about inflation,’ Mr Jerry Webman, chief economist at Oppenheimer Funds, told the Chicago Tribune.

He added: ‘We’re going to do other things which treat the problems but avoid going down the traditional monetary path straight into the jaws of inflation. The dissents were part of that message.’

In its statement, the central bank warned of further weakening in the economy and ‘considerable stress’ in financial markets. But one paragraph dwelt on the risks of inflation.

By cutting rates further, Fed chairman Ben Bernanke is placing a heavy bet that commodity prices and other leading indicators of inflation will come down on their own, aided by a slowing economy.

While allowing that ‘uncertainty about the inflation outlook has increased’, the Fed reiterated the view that slower growth and lower ‘resource utilisation’ will bring inflation back into the central bank’s comfort zone.

Given the inflation warnings, Mr Michael Lewis of Free Market said that ‘while the Fed may cut rates at the April 29-30 meeting, we expect that the easing arc is about finished’.

Mr Michael Woolfolk, currency strategist at Bank of New York Mellon, told the Chicago Tribune that the next step might be a coordinated effort by major nations to intervene in currency markets to support the US dollar.

Repeated Fed interest rate cuts, as well as a pessimistic outlook towards the US economy, has sent the greenback to record lows – worsening inflation by pushing up the prices of oil and other commodities.

REUTERS, WASHINGTON POST

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