Fed still divided on cutting interest rates, despite vice chairman Kohn's positive signals

The US Federal Reserve''s second-in-command, Fed Vice Chairman Donald Kohn, has hinted that the US central bank is prepared to be "flexible" on the possibility of cutting interest rates again at its 11 December meeting.

Speaking at the Council on Foreign Relations in New York, Kohn acknowledged that financial market turmoil could slow the US economy. "Uncertainties about the economic outlook are unusually high right now," he said; "these uncertainties require flexible and pragmatic policy-making; nimble is the adjective I used a few weeks ago."

Kohn''s remark sent Wall Street stocks soaring. The Dow Jones industrial average climbed more than 300 points, as investors read his remarks as a strong hint of another quarter point cut at the next Fed rate-setting meeting on 11 December.

But Kohn''s remarks contrast sharply with comments from other members of the Fed''s interest rate-setting committee. A speech by Dallas Fed Bank President Richard Fisher indicated that there was a split among policy-makers regarding the risks between inflation and growth.
 
"There are people at the table, myself included, that are very concerned about inflationary pressure. I don''t think we''re done in terms of getting it to where we want it to get," Fisher told a community forum in Amarillo, Texas.

Two other regional Fed bank presidents echoed his words on Tuesday. Chicago Fed chief Charles Evans said monetary policy was consistent with the Fed''s objectives of steady growth and low inflation, while Philadelphia Fed President Charles Plosser said that rate cuts risked inflation and could even slow the return of financial stability.

The difference between the tone of Kohn''s comments and the others could not be more stark. It indicates that the Fed''s 11 December meeting may be far more contentious than Wall Street anticipates.

This unprecedented exchange coincides with a separate Fed report that says the weak housing sector is becoming a drag on the rest of the US economy. The Beige Book, based on reports from the 12 regional Federal Reserve branches, notes that seven Fed districts had reported a slower pace of growth, while conditions in the remaining five districts were modest or mixed.

It says the pace of growth of the national economy has markedly slowed during the survey period of October through mid-November. Kohn admitted the deterioration since the Fed last met to discuss policy, on 30 and 31 October, when it lowered rates by a quarter point to 4.5 per cent, but said the risks to growth and inflation were roughly balanced.

"I have to admit that... the degree of deterioration… over the last couple of weeks was not something that I personally anticipated," he said in response to a question. Kohn said the central bank was looking at "lots" of different ways to supply liquidity to the markets.

US banks have written off billions of dollars in recent weeks owing to losses in the sub-prime credit market. This has once more brought turmoil to financial markets that had just recovered from the extreme jitters set off by credit fears in August.