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Rate cut: Policymakers debate how deep, and even if

Howard Schneider -

With the first US interest rate reduction in a decade expected later this month, two Federal Reserve policymakers sketched out arguments last week on how deep the cut should be, even as a third said she needs more data before being ready to sign on at all.

The remarks, from the chiefs of the Federal Reserve regional banks of Chicago, Dallas and San Francisco, show that the US central bank is edging towards a widely anticipated rate cut at its upcoming July 30-31 meeting without a consensus narrative about why a cut is needed, or even if it is.

The competing cases made on July 16 by the two policymakers supportive of a rate cut suggested the decision of whether to reduce rates by a quarter or a half of a percentage point could hinge on whether the goal is to guard against developing risks in the world economy and signalled by bond markets, or deliver a solid jolt meant to boost inflation in the United States.

“There is an argument that if I think it takes 50 basis points before the end of the year to get inflation up, then something right away would make that happen sooner,” Chicago Fed President Charles Evans told reporters at a CNBC economic forum.

Evans last week said he felt a reduction of half a percentage point in the Fed’s target overnight interest rate was needed for the US central bank to deliver on the 2 per cent inflation target that it has missed since setting it in 2012.

The Fed set the goal as a way to keep businesses and households forward looking, and help assure a modest pace of price and wage increases. Evans and others are concerned that if they continue to undershoot, they will lose credibility and their statements and policies will become less effective. The Fed’s current policy interest rate is set in a range of between 2.25 per cent and 2.5 per cent.

By contrast, Dallas Fed President Robert Kaplan, until recently a sceptic that rates should be cut at all, said he now thinks a “tactical” reduction of a quarter point could address the risks apparently seen by bond investors, who have pushed some long-term yields below shorter-term ones.

“If it was appropriate to take action, the best argument for me of why to do that is the shape of the curve,” Kaplan told reporters in Washington, referring to the “inversion” of the bond yield curve, a standard warning sign of recession.

The bond yield curve, when plotted as a graph, inverts from its typical arcing, upward slope when shorter-dated yields exceed those of longer-duration securities.

But neither the inversion of the yield curve nor concern about muted inflation or headwinds that may slow economic growth was enough to convince San Francisco Fed Bank President Mary Daly yet of the need to ease policy. “At this point I’m not leaning one direction or another,” Daly said in an interview, when asked about the Fed’s July rate decision. — Reuters

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