Sagging economy may prompt Fed to cut interest rates again

Tuesday, March 11, 2003

WASHINGTON -- The Federal Reserve may soon be forced to cut interest rates again, driving them to the lowest level since Dwight Eisenhower was president, amid fears that the shaky economy is about to fall back into recession.

Concerns about the anemic recovery from the 2001 downturn were heightened with last week's report that unemployment had risen to 5.8 percent in February, with a big loss of 308,000 jobs.

"Prior to the unemployment report, we thought the Fed would stay on hold for some months to come and the next move would be a rate hike, not a rate cut," Louis Crandall, chief economist at Wrightson ICAP, a bond market research firm, said Monday.

Now, Crandall said, he is forecasting a quarter-point rate cut at the March 18 Fed meeting.

Worries about an Iraq war continued to batter Wall Street on Monday with the Dow Jones industrial falling by 171.85 points to close at 7,568.18.

Last cut in November

The Fed last cut interest rates on Nov. 6, when it slashed its target for the federal funds rate, the interest that banks charge each other on overnight loans, to 1.25 percent, the lowest average since 1.17 percent in July 1961.

The funds rate has not been lower than 1 percent since it averaged 0.68 percent in July 1958, when Dwight Eisenhower was president.

Some economists believe the Fed might cut rates by a half-point, the same move it made in November, when it cited the drag on the economy from "geopolitical risks" such as worries about a possible war in Iraq.

Before the dismal unemployment report, most economists believed that the Fed stand pat in March, as it did in December and January, believing that it had already done enough to guarantee the economy would rebound more strongly once the uncertainty of the war was removed.

Federal Reserve chairman Alan Greenspan even told Congress in mid-February that President Bush's economic stimulus package of new tax cuts would probably not be needed because the economy would begin growing at healthier rates once businesses grew more confident and began increasing their investment spending.

Worried about job losses

But the job losses in February were so dramatic that analysts quickly lowered their growth estimates. Analysts at J.P. Morgan slashed their forecast for growth in the first six months of this year from 3 percent to 1.5 percent.

Financial markets were also quick to respond to the jobless report, with federal funds contracts -- bets on future Fed rate moves -- putting the possibility of a March rate cut above 40 percent, up from 22 percent before the jobless report was released.

Many economists said that even if the Fed doesn't cut rates at the March meeting, policy-makers could use an emergency telephone conference call to change rates between meetings. The next discussion on interest rates after March will not occur until May 6.

If the United States does go to war with Iraq and achieves a quick victory which jump-starts U.S. economic growth, then the Fed may see no need to cut rates further.

However, if the war goes badly, with significant disruption to oil supplies leading to soaring oil prices, analysts said the central bank will not hesitate to use all its remaining interest rate ammunition.

"In a messy war scenario, the central bank would cut short-term interest rates toward zero," predicted Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. He said that given how weak the economy is, the Fed is not worried that higher oil prices will trigger inflation troubles.

"Today, the central bank is more worried about deflation than inflation," Sohn said.

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