Fed Set to Cut Rates to 45-Year Lows

Policymakers at the U.S. Federal Reserve (searchwill wrap up a two-day meeting Wednesday that was expected to result in a 13th drop in interest rates designed to light a fire under a flagging recovery.

The meeting, aimed partly at preparing Fed Chairman Alan Greenspan (searchfor semi-annual economic testimony to Congress next month, will also discuss the risk of price deflation, the Fed chief has said.

Top Wall Street dealers surveyed by Reuters last week were unanimous in anticipating a reduction in the current 1.25 percent federal funds rate by either a quarter or a half percentage rate -- taking it to the lowest level in 45 years.

The Fed likely will stick with an assessment that risks to the economy are tilted to the downside because of deflation worries (search), a position adopted at its last policy session on May 6, economists said.

The rate-setting Federal Open Market Committee started the session on Tuesday afternoon and was scheduled to resume at 9:00 a.m. on Wednesday. A decision on rates was due out at about 2:15 p.m.

Since the world's largest economy slipped into a mild recession at the start of 2001, the Fed has brought down its key fed funds rate -- for overnight loans between banks -- from 6-1/2 percent to its current 42-year low.

Growth resumed in 2002 but haltingly, at around a 2 percent annual rate, far below its generally accepted potential rate of 3 to 3-1/2 percent. The national unemployment rate crept up to 6.1 percent from below 4 percent in late 2000.

Meanwhile, the "output gap" between the economy's potential and actual performance has widened, so analysts say the Fed wants growth to exceed that traditional potential pace for a time, to absorb excess capacity and foster job creation.

Dick Berner, an economist with Morgan Stanley in New York and chair of the Bond Market Association's economic advisory committee, said Tuesday its members think the Fed will signal it will do everything it must to revitalize growth and dampen deflation fears.

"We can see at least two or perhaps more years of above-trend strong growth without closing that gap," Berner said, adding, "Certainly it's part of my own view that inflation is not likely to be a problem soon so we can afford stimulative policies to get the economy back on track."

The association foresees economic expansion at around a 3.5 percent annual pace over the second half of 2003, a sharp rise from the 2 percent rate they expect for the second quarter.

Economist Anthony Chan of Banc One Investment Advisors Corp. in Columbus, Ohio, said he expected a quarter-percentage point cut from the Fed and reassurance that better times lie ahead. But he said there will also be an implicit promise it will do more if it must to avoid the impression that the rate-cutting cycle is over.