After rate cuts, Fed plays wait and see

By Helen Huntley, Times Personal Finance Editor
In print: Thursday, May 1, 2008

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After seven cuts in short-term interest rates, including another quarter point Wednesday, and tax rebates kicking off this week, now comes the moment of truth:

Will the government's economic cure work?

"It's time to take a breather and see how this plays itself out," said University of Central Florida economist Sean Snaith in Orlando. "If you've got pneumonia and the doctor gives you some penicillin, if you take it for a day or two and then when you're no better, you rush back and get another prescription, that runs the risk of overdose. We don't want to rush back for more stimulus until we've seen what we've done."

But small business owners like Jack Coudoux, who runs Sandy's Auto Repair in Clearwater, wonder if the federal fixes go far enough to get the economy back on track.

"It didn't take just one thing to make this happen and not just one thing is going to fix it," said Coudoux. He said property insurance rates and taxes remain a big impediment to recovery.

Coudoux said five repair shops within a block of his have shut down in the past six months. "It's a weeding out, a cleaning out, and the strong will survive," he said.

Each time the Federal Reserve cuts rates, it takes six months to a year for the effects to work their way through the system as adjustable rate loans reset and borrowers take out new loans at lower rates.

The Fed started cutting last September when the federal funds rate, the rate at which banks lend each other money overnight, was 5.25 percent. After Wednesday's cut, the rate is at 2 percent.

Other recent efforts to help the economy also take time to make an impact, from new programs to help homeowners stave off foreclosure to the $168-billion congressionally engineered spending spree that soon should be giving retailers a pickup. The first stimulus rebate checks started to hit bank accounts Monday. While most will be delivered by mid July, checks will continue to go out for the rest of the year.

"The Fed can always cut rates again if the economy really starts to weaken a lot more," said Scott Brown, senior economist at Raymond James & Associates in St. Petersburg. So far the official numbers show it hasn't slowed as much as expected.

The Commerce Department reported Wednesday that the economy grew at a slight 0.6 percent annual rate in the first quarter. That means we're not officially in a recession.

"The bad news is that the economy is trending about flat," Brown said. "The good news is that it's not totally fallen off a cliff. A lot of people had anticipated a lot more downside."

The Fed's actions have helped homeowners whose adjustable rate mortgages were resetting. They also have led to lower rates on other variable-rate loans, including home equity credit lines and credit cards, and on short-term savings accounts such as money-market funds and bank CDs.

The big risk of lowering rates too aggressively is that lower rates fuel inflation. But in its statement Wednesday, the Fed said it expects inflation to moderate as energy and other commodity prices stop climbing.

The Fed's statement was more ambiguous than usual about its future plans, saying it "will act as needed to promote sustainable economic growth and price stability." Most analysts read that as an indication that the Fed is taking a wait-and-see attitude.

The stock market reacted unhappily to the uncertainty, falling back after having run up in anticipation of the Fed cut.

Will the Fed cuts be enough?

"I think we've got a touch-and-go situation," economist Snaith said.

However long the recovery takes, consider some pain a necessary part of the process, said Clearwater financial adviser Ray Ferrara, president of ProVise Management Group.

"We've got to go through these difficult times to get back to the good times," Ferrara said. He said he expects one more rate cut before the Fed reverses course, although it may not be at the next meeting, which is June 24 and 25.

Helen Huntley can be reached at hhuntley@sptimes.com or (727) 893-8230.