Does the Fed's rate cut help consumers?

Is the Fed likely to cut interest rates again in December?
— B.A., Indiana

We used to rely on the Answer Desk crystal ball to handle questions like this one, but every time we asked about the future direction of interest rates, it blew a circuit breaker. So we traded it in for a big screen TV.

Since then, we haven’t found anyone who can predict which way interest rates are headed — though there’s no shortage of people on business cable channels who are willing to try. About the best you can do is look at the same economic trends and financial forces that the folks at the Federal Reserve are watching, add a pinch of politics, and make your own forecast.

The Fed’s surprise half-point cut in September was designed to “shock and awe” the money markets to get them flowing again after a worldwide credit panic brought lending to a near standstill. Think of it as a gigantic, global financial defibrillator. (In this case, Chairman Bernanke forgot to shout: "Clear!")

The treatment seems to have worked, though the patient is still feeling a little woozy. So last week, the Fed cut short-term rates by another quarter point because of continued worries that the housing recession could spread to the wider economy. The markets had already placed bets that a rate cut was coming, in part because Wall Street is still worried about recent mortgage-related losses now being reported by banks and other lenders. Last week's 360-point air pocket in stock prices was due mainly to worries that banks may have to report more multi-billion losses down the road.

But the Fed accompanied the latest rate cut with a clear statement — or about as clear as the Fed ever gets – that, based on current conditions, it’s not inclined to cut rates further. Like a flustered parent at the supermarket checkout with a pack of kids Jonesing for a candy fix, Chairman Bernanke et al essentially said, “OK, OK. Just one! But this is the last time!” 

Further rate cuts are going be harder to justify unless the Fed gets clear signals that the economy is slipping into recession, and the latest data just don’t show that happening ... yet. Last week’s first peek at third quarter gross domestic product showed the economy humming along at nearly 4 percent, a reading that was echoed in Friday's stronger-than-expected report on new jobs created in October.

The Fed also has to keep a close watch on a potentially bigger threat: a return of inflation. As central bankers learned the hard way in the 1970s, once inflation gets started it can be very difficult — and painful — to stop. The latest inflation gauges used by the Fed show that prices are still fairly stable. But with oil approaching $100 a barrel, at some point those higher energy costs will start showing up in the cost of everything from gasoline to plastic packaging to shipping. Companies can — and do — absorb those costs for awhile. But when profits get squeezed too hard, they have no choice but to pass those costs along to consumers — or close up shop. That means inflation, or recession, or both.

The other number to keep an eye on — because the Fed is too — is the value of the dollar. A weaker dollar has already pushed up the price of gold and other commodities (in dollar terms). That’s bad news on the inflation front. Food prices are also rising — not a big deal in the short term, but worrisome if those price increases persist.

In the end, no one really knows what the Fed is going to do next, including the members sitting around that big table behind closed doors. A lot depends on what happens — especially as reported in the economic data — between now and the next time they sit down in December.   

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