Market swings won't deter Fed's focus on inflation

WASHINGTON - DESPITE another nervous day for stock markets on Thursday, the US Federal Reserve will remain focused on ensuring that inflation is convincingly under control before it considers dropping interest rates.

Equity markets in the United States stumbled out of the gate on Thursday, with the Dow Jones Industrial Average slipping by as much as 209 points before recovering to end down only 34 points, helped by data showing an unexpected pickup in factory activity.

'We're still a pretty long way from a situation where the Fed would ease policy in response to financial market turmoil,' said Goldman Sachs analyst Jan Hatzius. 'Things have to get a lot worse than what we've seen for that to even be on the table.'

The latest market turbulence came two days after US equities suffered their biggest one-day drop since 2001, raising the spectre of a deeper economic retrenchment. Fed chairman Ben Bernanke provided some reassurance on Wednesday when he said markets were functioning normally and that the US economy still looked on course for steady growth.

Still, markets early on Thursday moved to fully price in two quarter percentage point rate cuts by year-end, with the first one fully expected by August.

As the stock market stabilised, those bets were scaled back and the implied chances of a cut by August edged down to about 85 per cent.

At times in the past, the Fed has lowered rates to counteract market stress, as it did in 1998 as financial crises spread from Asia to Russia.

But unless market swings become much more pronounced, the Fed is likely to continue to focus on ensuring that underlying inflation, excluding food and energy costs, moves to levels it is more comfortable with.

A report from the Commerce Department on Thursday showed that core prices, as measured by the Fed's favoured gauge, rose 0.3 per cent in January, taking the year-on-year increase up to 2.3 per cent from 2.2 per cent in December. This is still stubbornly above the 1 per cent to 2 per cent range that is the Fed's perceived preference.

The several days of market turmoil and conflicting economic reports are, however, moving some analysts to lower their forecasts for US economic growth.

'The odds of a recession have gone up in the last two weeks,' said Mr David Shulman, a senior economist with the Anderson Forecast at the University of California at Los Angeles.

The forecast group is lowering its expectations for economic growth primarily because it believes the turmoil in the market for risky mortgage loans will prolong and deepen the housing slump, he added. It will not release its updated forecast until April.

More optimistic observers, however, disagree.

'Overall, the economy is in great shape,' said Mr Bernard Baumohl, managing director of the Economic Outlook Group, who argues that buoyant consumer spending will more than offset the economy's soft spots.

The disagreement is typical of a time when the figures are mixed, and it is unclear how consumers will respond to falling stock prices. If consumers pull back now, the economy is likely to falter, several analysts said.

REUTERS, WASHINGTON POST





LOW CHANCE OF RATE CUT

'We're still a pretty long way from a situation where the Fed would ease policy in response to financial market turmoil. Things have to get a lot worse than what we've seen for that to even be on the table.'
MR JAN HATZIUS, a Goldman Sachs analyst