Fed Trims Rates Again, but Hints at a Pause

WASHINGTON — The Federal Reserve trimmed short-term interest rates by a quarter of a percentage point on Wednesday, the seventh cut in seven months.

But the central bank also signaled it likely would pause its rate-cutting campaign, which so far has pushed down the federal funds rate to 2 percent from 5.25 percent.

Rather than continue trying to spur growth by making loans cheaper, the Fed may shift its focus toward containing rising prices.

"Some indicators of inflation expectations have risen in recent months," the Fed said in a statement that accompanied its announcement of the reduction in the key federal funds rate, which banks charge each other for loans. "It will be necessary to continue to monitor inflation developments carefully."

The Fed's policy makers voted 8-2 in favor of the cut. The two dissenters, Dallas and Philadelphia Fed presidents Richard Fisher and Charles Plosser, preferred no cut. The Fed also lowered the discount rate, which it charges on loans to banks and securities dealers, by a quarter point to 2.25 percent.

Daniel Meckstroth, chief economist for the Manufacturers Alliance/MAPI, a nonprofit group that conducts manufacturing research, applauded the majority's decision in light of Commerce Department data released earlier in the day.

That report showed that the U.S. gross domestic product, a measure of all goods and services produced, grew at a sluggish 0.6 percent in the first quarter. Still, the economy was growing, not shrinking, a sign that a recession might still be avoided.

"The Fed took a sensible approach," Meckstroth said. The Fed policy makers don't want to stir up inflation, but they also want to keep interest rates low enough to help borrowers survive a difficult economy, he said.

"Inflation is a budding problem, but the GDP report suggests the economy over the last six months has been virtually flat," he said. So the Fed split the decision, lowering interest rates but hinting that no more cuts are coming, he said.

Investors seemed to be less pleased by the Fed's action. The Dow Jones industrial average, which had been up about 175 points just before the announcement, ended the day down about 12 points.

In its statement, the Fed emphasized that while it worries about inflation, it understands a lot of people are still hurting. "Economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress," it said.

The Fed's cut immediately began to ripple out to consumers and business owners. Major banks announced they would drop their prime lending rates by a quarter percentage point to 5 percent. The prime rate, which banks charge their best business customers, serves as a peg for setting interest rates on home-equity loans, credit cards, car loans and other consumer loans.

While lower interest rates can help borrowers, they can worsen inflation. Lower U.S. rates discourage foreign investors from owning dollars. When investors send their savings to countries that pay higher returns, the U.S. currency weakens. And a weaker dollar drives up the cost of imported foods and fuels for U.S. shoppers.

Also, lower interest rates encourage investors to switch from buying U.S. Treasuries to bidding on commodities such as corn, wheat and oil, driving those prices higher.

Moreover, many economists say lower interest rates may no longer be the right medicine for the economy. The biggest problem now is the real estate market, which is burdened by huge inventories of unsold homes. No amount of rate-cutting would spur builders to rehire crews and start putting up more houses, at least not for a long time.

In addition, more rates won't help the weakest borrowers, who can't get loans no matter how cheap they are.

Even as interest rates become a less effective weapon for fighting recession, other types of stimulus are about to kick in. For example, the central bank is lending more money to banks and Congress has ordered the Treasury to send out tax rebate checks.

All of which suggests "this will be the last rate cut in the Fed's current easing campaign," Richard Yamarone, economist for Argus Research, said in a written analysis.

Yamarone said inflation measures are pointing toward trouble. "The surge in prices ... suggests a heightened degree of inflationary pressures," he said. By December, the Fed probably will have to raise rates again to restrain demand enough to cool prices, he predicted.