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Fed official’s comments raise rate cut hopes

Federal Reserve Vice Chairman Donald Kohn said on Wednesday he factored some tightening of credit from the financial turmoil into his policy decisions, raising hopes on Wall Street for another interest rate cut.
/ Source: Reuters

Federal Reserve Vice Chairman Donald Kohn said on Wednesday he factored some tightening of credit from the financial turmoil into his policy decisions, but recent turbulence may restrict credit more than previously thought.

The Fed official’s comments were taken by some on Wall Street as a hint that another interest rate cut may be in the offing when the Fed’s policy-setting panel meets again December 11.

The U.S. central bank reduced interest rates by a cumulative three-quarters of a percentage point at its September and October meetings to buffer the economy from the shocks of a rise in mortgage defaults and credit market disruptions.

“The increased turbulence of recent weeks partly reversed some of the improvement in market functioning over the late part of September and October,” Kohn said in a speech to the Council on Foreign Relations in New York.

“Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses,” he said.

Kohn’s comments come after large U.S. banks, in recent weeks, announced billions of dollars in write-downs due to losses from mortgages and other debt.

“Uncertainties about the economic outlook are unusually high right now,” he said. “These uncertainties require flexible and pragmatic policymaking — nimble is the adjective I used a few weeks ago.”

Kohn said higher borrowing costs could be expected to discourage spending, and would normally call for offsetting monetary policy action. He said he had taken some restraint on demand into account when he weighed interest rate cuts at the Fed’s September and October meetings.

However, on Tuesday two Federal Reserve Bank officials hinted strongly that they would not support an interest rate cut in December, contending that the Fed has provided enough insurance against financial turmoil and would risk opening the door to higher inflation.

The comments from Chicago Fed President Charles Evans and Philadelphia Fed President Charles Plosser put the central bank at odds with financial markets that are anticipating a series of rate cuts over the next few months.

Many Fed watchers see further easing as a necessity given the almost daily widening of turmoil in global credit markets — conditions that have worsened even since the most recent Fed policy meeting in late October.

Many see a rising chance of an economic recession in 2008 as falling house prices erode consumer confidence and consumer spending in turn.

But Evans and Plosser, while acknowledging risks to the economy, suggested that further cuts to the federal funds rate, the bank’s most powerful policy tool, might not be the right solution to the credit market's problems.