Friday, September 12, 2008
Sept. 12 (Bloomberg) — Federal Reserve Chairman Ben S. Bernanke and his fellow policy makers agreed at their August meeting that their next move on interest rates would probably be up. They may turn out to be wrong.
Inflation looks likely to ebb, thanks to falling commodity prices and contained labor costs. The U.S. economy, meanwhile, may be set to take another lurch down as consumer spending gives way and the credit crunch intensifies with the plunge in Lehman Brothers Holdings Inc.’s shares.
“If the consumer balance sheet starts to unwind quickly, you’d get another disinflationary force and then the Fed would be brought back into play with lower rates,” says Mohammed El- Erian, co-chief executive officer of Pacific Investment Management Co. in Newport Beach, California.
Bernanke and his colleagues are likely to hold their benchmark rate at 2 percent when they meet Sept. 16 and may keep it there until 2009, trading in federal funds futures indicates. Still, the odds of a rate cut by year-end have been growing. Futures trading shows more than a 40 percent chance of a December reduction, up from zero odds at the beginning of September.
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Traders increased their bets after government figures today showed sales at U.S. retailers unexpectedly dropped in August and a bigger-than-forecast decline in wholesale prices signaled inflationary pressures may ease.
San Francisco Fed President Janet Yellen left open the possibility of a rate cut in comments to reporters after a Sept. 4 speech in Salt Lake City. “There is some chance” of easing credit “if things start going seriously wrong,” she said.
She made clear, though, that she agreed with her fellow policy makers, who “generally anticipated that the next policy move would be a tightening,” according to the minutes of the Fed’s last meeting on Aug. 5.
If the Fed instead ends up lowering borrowing costs, it wouldn’t be the first time Bernanke and his colleagues have been forced to shift their stance from fighting inflation to supporting growth. When the credit crisis first struck in August 2007, the Fed cut its discount rate on loans to banks just 10 days after declaring that inflation was its overriding concern.
Investors have remained on edge since then, even after the Fed-assisted takeover of Bear Stearns Cos. in March and the rescue of Fannie Mae and Freddie Mac this month. Shares in Lehman Brothers dropped more than 70 percent this week as the firm reported a record $3.9 billion loss for the third quarter and concern mounted about its capital levels.