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Jan. 29 (Bloomberg) -- The Federal Reserve may push interest rates below the pace of inflation this year to avert the first simultaneous decline in U.S. household wealth and income since 1974.
The threat of cascading stock and home values and a weakening labor market will spur the Fed to cut its benchmark rate by half a percentage point tomorrow, traders and economists forecast. That would bring the rate to 3 percent, approaching one measure of price increases monitored by the Fed.
Negative real rates are "a substantial danger zone to be in,'' said Marvin Goodfriend, a former senior policy adviser at the Richmond Fed bank. "The Fed's mistakes have been erring too much on the side of ease, creating circumstances where you had either excessive inflation, or a situation where there is an excessive boom that goes on too long.''
Lower rates could aggravate inflation. Consumers and businesses already are smarting from high energy prices. Dropping rates even more can further weaken the dollar. That could raise the cost of imported goods coming into the United States and lead American companies to raise their prices as foreign-made goods become more expensive.
Low rates, over time, could lead some people to live a lifestyle that they cannot afford.
"You could see a restart to some of the behavior that was so prevalent just a couple of years ago, where borrowers were relying on home equity lines of credit and other inexpensive forms of credit to fund their discretionary spending," said Greg McBride, senior financial analyst at Bankrate.com.
Short-term adjustable-rate mortgages could become much cheaper than longer term fixed-rate mortgages if the interest rate-cutting campaign continues. Home buyers could flock to the adjustable mortgages without seriously considering whether they could afford their mortgage payments if rates climbed. That is just what happened during the housing market's record-breaking days from 2001 through 2005. Today, record numbers of people have been forced from their homes - clobbered by rising interest rates and weak home values once the boom went bust.
Originally posted by Karlhungis
That would make it a 1.5% drop in about a weeks time. They had to be hoping that the .75% cut last week would last a tad longer. I have had the feeling that they are just trying to limp us along until bush is out of office, that way the collapse happens on someone elses watch, but now it looks like they are running out of options.
Originally posted by NWRHINO
So, who does the FED expect to borrow money in a recession?
Homeowners and debt ridden consumers?
The Federal Reserve on Wednesday cut interest rates by another 50 basis points and signalled that the door was open to further reductions in an aggressive move to combat the risk of a US recession.
The dollar meanwhile fell to a record low against the euro before closing slightly higher.
The 50 basis point reduction in the Federal Funds rate came hot on the heels of last week’s emergency 75 basis point cut. The combined 125 basis point reduction represents the most abrupt easing of monetary policy by the US central bank since the early 1980s.
Some observers criticised the Fed for bowing to the short-term priorities of financial markets.
"The Fed looks foolish. It seems they're afraid of the market," said David Greenwald, a partner at Scalene Capital Management.
"Everyone knows that it takes a while for 75 basis points to get through the economy and by cutting 50 now, I just think they're not leaving much room in the future."
The 0.6% figure meant that the US economy grew by 2.2% in 2007 as a whole - the weakest expansion seen since the 1.6% growth recorded in 2002, when the economy was affected by the dot.com collapse and the aftermath of the September 2001 terrorist attacks.
Spending on new-home building dropped at an annual rate of 23.9% in the fourth quarter, the biggest quarterly drop in 26 years, after falling 20.5% in the third quarter. Over the course of the full year, residential spending fell 16.9%, the worst annual performance since the deep decline of 1982, when double-digit interest rates were used to bring down inflation.
The figures suggested the US may be suffering from a mild dose of stagflation - weakening activity plus higher inflation.
A gauge of prices favoured by the Fed - personal consumption spending excluding food and energy items - gained at a 2.7% annual rate in the fourth quarter. That was well ahead of the third quarter's 2% increase and Wall Street expectations. It was the biggest increase for any three months in one-and-a-half years.
Alan Greenspan, the former chairman of the Fed, said today that the chances of a US recession were greater than 50-50. The technical definition of a recession is two consecutive quarters of contraction. Many analysts think the US is already in a recession.