Washington: The Federal Reserve may push interest rates below the pace of inflation this year to avert the first simultaneous decline in US household wealth and income since 1974.
The threat of cascading stock and home values and a weakening labour market will spur the Fed to cut its benchmark rate by half a percentage point today, economists forecast. That would bring the rate to three per cent, approaching one measure of price increases monitored by Fed.
"The Fed is going to have to keep slashing rates, probably below inflation," said Robert Shiller, the Yale University economist who co-founded an index of house prices. "We are starting to see a change in consumer psychology."
So-called negative real interest rates represent an emergency strategy by Chairman Ben Bernanke and are fraught with risks. The central bank would be skewing incentives towards spending, away from saving, typically leading to asset booms and busts that have to be dealt with later.
Negative real rates are "a substantial danger zone to be in", said Marvin Goodfriend, a former senior policy adviser at the Richmond Fed bank. "The Fed's mistakes have been erring too much on the side of ease, creating circumstances where you had either excessive inflation, or a situation where there is an excessive boom that goes on too long."
Adjusting outlook
The Federal Open Market Committee began its two-day meeting yesterday and will announce its decision at about 2.15pm in Washington today. Officials will also discuss updates to their three-year forecasts at the session.
Bernanke and his colleagues on January 22 lowered the target rate for overnight loans between banks by three-quarters of a percentage point. The cut was the biggest since the Fed began using the rate as its main policy tool in 1990 and followed a slide in stocks from Hong Kong to London that threatened to send US equities down by more than 5 per cent.
The central bank will probably lower the rate to at least 2.25 per cent in the first half, according to futures prices quoted on the Chicago Board of Trade. The chance of a half-point cut is 86 per cent, with 14 per cent odds on a quarter- point.
Stocks rose in Europe and Asia yesterday as traders anticipate the next rate cut. The MSCI World Index added as much as 0.8 per cent, taking it to 1,454.62. It is down about nine per cent so far this year. Futures on the Standard & Poor's 500 Index rose 0.2 per cent.
Inflation, as measured by the personal consumption expenditures price index minus food and energy, was a 2.5 per cent annual rate in the fourth quarter, economists estimate. The Commerce Department releases the figures today.
The last time the Fed pushed rates so low was in 2005, in the middle of the three-year housing bubble, when consumers took on $2.9 trillion in new home-loan debt, the biggest increase of any three-year period on record.
