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Fed rate cut benefits might be months away

While the Federal Reserve's aggressive drive to lower interest rates appears to be over, there could be benefits for consumers in other places — like some relief from soaring gasoline and food costs.
/ Source: The Associated Press

While the Federal Reserve's aggressive drive to lower interest rates appears to be over, there could be benefits for consumers in other places — like some relief from soaring gasoline and food costs.

"With the Fed on hold and the dollar firming, oil and gasoline and food prices may all top out some time in the next few months," said Mark Zandi, chief economist at Moody's

On Wednesday, the Fed cut interest rates for a seventh straight time. But the reduction was a much smaller quarter-point move — not the half-point and three-fourths-point moves of earlier this year. It pushed the federal funds rate down to 2 percent.

Commercial banks immediately followed suit by cutting the prime lending rate, the benchmark for millions of consumer and business loans, to 5 percent, the lowest level since late 2004.

That may be as low as consumer rates go during this Fed easing cycle because the central bank sent a number of signals that it believed it may have done enough to keep the economic slowdown from deepening into a severe recession.

Several analysts said the central bank was recognizing the realities of the situation that it may have done all it should do to try to boost growth through rate cuts, given growing threats from inflation.

"The Fed may have gotten to the point where it could start hurting economic prospects in terms of the value of the dollar and oil prices and grain prices," said Sung Won Sohn, an economics professor at California State University. "It think it was time for the Fed to slow down and take a pause."

Lower U.S. interest rates tend to make the dollar's value against other currencies weaker because investors dump their U.S. holdings in favor of investments in other countries where they can earn a higher interest rate.

As the dollar falls, that tends to drive the cost of oil higher because oil is priced in dollars and producers start demanding higher prices to compensate for a weaker dollar. Those forces are also at work in terms of driving up other globally trade commodities such as metals and food including wheat and other grains.

With the Fed lowering the prospects for further rate cuts, the dollar can be expected to stabilize and perhaps rebound from the record lows it had hit in recent weeks against the euro and other currencies. That should help various commodities including oil and food to backtrack from their recent record highs, a process that may have already started.

Oil, which fell on the Fed's Wednesday announcement, dropped further in trading on Thursday as the dollar continued strengthening against the euro and other currencies. In trading on the New York Mercantile Exchange, crude oil dropped $3.03 to $110.43 a barrel, its lowest level since April 14 and down significantly from the record near $120 per barrel earlier in the week.

Analysts said it will take time, however, for motorists to see the benefits in lower gasoline costs, which hit another record nationwide average of nearly $3.623 per gallon of regular on Thursday, according to a survey of stations by AAA and the Oil Price Information Service. Analysts said gasoline is likely to keep heading higher for a time because refiners have not been able to raise their prices fast enough to recoup the crude oil surge that has already occurred.

But private economists believe that if the dollar does stabilize and oil and other commodities begin to fall in a sustained way, consumers will start seeing benefits in two to three months.

Of course, part of that forecast depends on the Fed deciding to stay on the sidelines and not cut rates further, an expectation that is heavily dependent on the course of the overall economy. There was some good news Wednesday in that the gross domestic product did expand — albeit at a tiny 0.6 percent rate — in the first quarter rather than contracting.

But analysts say the country is not out of the woods in terms of avoiding a recession, and many believe GDP growth could turn negative in the current quarter. As long as the downturn is mild, analysts believe the Fed will keep rates unchanged because of their worries that further rate cuts could fuel a rise in inflation that may be hard to deal with, risking a repeat of the stagflation nightmare of the 1970s.

"The Fed lost control of inflation in the 1970s by pushing interest rates too low and boosting inflation expectations," said David Jones, chief economist at DMJ Advisors. "The Fed more than anything else wants to avoid a repeat of that episode."