By Vivien Lou Chen and Steve Matthews
Oct. 3 (Bloomberg) -- Two Federal Reserve district bank presidents signaled they're not prepared to back an interest- rate cut even after the biggest disruption to the U.S. financial industry in seven decades.
``Lowering the rate right now maybe isn't the right response'' because of an ``inflation problem,'' St. Louis Fed President James Bullard said after a speech in Bloomington, Indiana, late yesterday. Thomas Hoenig, his Kansas City counterpart, said in Albuquerque, New Mexico, that ``there is very strong stimulus in the economy'' already.
The remarks underscore a gap between investors' expectations of further rate reductions and the sentiment among some regional Fed officials that more cuts may not aid the economy at a time of elevated inflation. Five of the 12 district-bank chiefs dissented on rate decisions since policy makers started lowering borrowing costs in September last year.
Traders may look to Fed Chairman Ben S. Bernanke's Oct. 7 speech on the economy for clues on whether the Federal Open Market Committee is open to a cut even before its Oct. 28-29 meeting. Bullard and Hoenig aren't voters on the FOMC this year.
Interest-rate futures indicate 94 percent odds of a half- point cut in the Fed's benchmark 2 percent rate at or before this month's meeting. A month ago, futures showed no chance of any reduction.
Expectations shifted after the turmoil that brought down Lehman Brothers Holdings Inc. last month and caused government takeovers of Fannie Mae, Freddie Mac and American International Group Inc., along with forced mergers or asset sales by Merrill Lynch & Co., Wachovia Corp. and Washington Mutual Inc.
Banks are hoarding cash as the crisis deepens. The London interbank offered rate that banks charge each other for three- month loans rose for a fourth day yesterday to 4.21 percent, the highest since Jan. 11.
``When the markets freeze up, and people become afraid and don't trust one another and are not willing to lend to one another, then of course the ability for monetary policy to work is more complicated and more difficult and less immediately effective,'' Hoenig said in responding to questions yesterday.
Still, he said the Fed's challenge would be to take back some of the seven rate cuts implemented from September 2007 to April this year.
``One of the most difficult tasks ahead for the central bank is to remove that accommodation, remove that liquidity, in a timely manner,'' Hoenig said at a forum sponsored by his bank late yesterday. ``If you do it too quickly, too rapidly, then we may staunch the recovery that we're trying to achieve.''
Hoenig, 62, took office in October 1991 and is the second- longest serving of the district bank presidents, after Minneapolis's Gary Stern.
Five presidents serve on the FOMC, which also includes the seven governors on the Fed's board; one governorship slot is currently vacant. The New York Fed chief is permanent FOMC vice chairman, with four other presidents rotating on an annual basis.
Bullard, 47, took the St. Louis Fed's helm in April after serving as the bank's research director. He stressed his concern about inflation dangers yesterday.
``You've got this brewing inflation problem that could get out of control if we don't keep our eye on it,'' he said. ``The key concern for me is that we don't get so wrapped up in trying to solve the financial crisis that we create a new problem, a new inflation problem.''
Both Bullard and Hoenig said the financial crisis is taking its toll on the U.S. economy.
``Financial market turmoil has recently been severe, and the consequences of this turmoil on real economic performance entail clear downside risk,'' Bullard said in his speech. ``The things that have given me the most concern are the labor market data and the sharp rise in the unemployment rate'' and jobless claims that are ``at recession levels,'' he said afterward.
Hoenig said that the U.S. economic situation is ``very serious,'' with consumers likely to rein in spending and increase savings amid the financial tumult.
The Kansas City Fed official said he was ``very concerned'' about the economy, while reiterating his confidence that the U.S. will ``see its way through this.'' Growth will be ``very modest'' this quarter, with a chance of improvement by the second quarter of 2009, he said.
The central bank said yesterday it had extended a record total of $410 billion of loans to commercial banks, securities dealers and AIG as of Oct. 1 in its efforts to help buttress liquidity.
House of Representatives lawmakers today may vote on a $700 billion rescue plan to help shore up the financial industry, after the Senate approved a modified version of legislation the House originally rejected.
Manufacturing in the U.S. contracted in September at the fastest pace since the last recession as sales slowed, and orders to U.S. factories fell in August by the most in almost two years, according to figures released this week.
The U.S. probably lost jobs in September for the ninth consecutive month, economists said before a report that will be released today. Payrolls probably fell by 105,000, according to the median estimate in a Bloomberg News survey.
To contact the reporter on this story: Vivien Lou Chen in San Francisco at firstname.lastname@example.org
Last Updated: October 3, 2008 01:10 EDT