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Worries about the slowing economy continue to trump inflation concerns, while the Fed leaves the door open for more cuts.
The Federal Reserve's cut of a half-percentage point in interest rates today, following close on the heels of last week's three-quarters of a point reduction, probably won't keep the economy out of negative territory this quarter. The real question is whether the cuts that came before it, starting with the trimming of a quarter of a percentage point last September, will have enough of an impact to pull growth into positive numbers again this spring.
It generally takes six to 12 months for the full impact of rate cuts to work through lending and spending channels. So, most of the impact from the Fed's cuts won't show up until the second half of this year. That's also when the package of tax breaks now being hammered out in Congress should begin to boost consumer and business spending. Taken together, the result should be enough to keep gross domestic product (GDP) in positive territory for the year as a whole, up between 1% and 2%, but can do little or nothing to reverse a downturn this quarter and possibly next. Today's action by the Fed came just after release of fourth-quarter GDP numbers, showing that the economy sharply decelerated to 0.6% growth, dangerously near recession territory. In comparison, the annual GDP grew 2.2% in 2007 and 2.9% in 2006.
Two economic indicators due out on Friday, Feb. 1, will offer clues to how this year is starting off and whether additional interest rate cuts by the Fed are likely. Job growth of less than 50,000 in January and an unemployment rate that ticks higher would spell bad news: Insufficient job growth to continue to prop up income and consumer spending. In December, the jobless numbers rose from 4.7% to 5%, while the economy added only 18,000 net new jobs.
Keep an eye, also, on the results of the purchasing managers' survey in January, which will be a tip off on how manufacturing is holding up. While manufacturing plays a smaller role in today's service-dominated U.S. economy, the survey should reveal whether export growth will continue to help offset blows from housing's downturn and auto cutbacks. An index number of 47 or higher would prove reassuring, indicating at least weak expansion, while a number in the low 40s would signal contraction.
Figures showing continued deterioration in the economy will put the Fed in a bind. Critics fear that additional rate cuts will fan inflation -- when the economy perks up again. The personal consumption deflator minus food and energy, an inflation marker closely watched by the Fed -- rose 2.7% in the fourth quarter of 2007, up from 2% in the third quarter and well above the outer limit of the Fed's 1%-2% goalposts. Long considered an inflation "hawk," Chairman Ben Bernanke has nevertheless made it clear that inflation concerns should take a backseat in policy decisions as long as the economy is getting weaker.
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This article is reprinted with the permission of KiplingerForecasts.com. The web site includes the online edition of the weekly Kiplinger Letter, plus additional forecasts and guidance for critical business sectors.
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