reality-based educator

The Federal Reserve Open Market Committee meets later this month to decide whether to further cut rates to stave off problems to the overall economy from the credit crunch and the housing bubble burst.

Wall Street still expects at least one more rate cut this year either at the October or December FOMC meetings.

The Financial Times reports that Fed chair Ben Bernanke said in a speech on Monday that while the September rate cut of 50 bps seems to have improved the functioning of the credit markets and reduced the risk to the near-term economic outlook, the “ultimate implications of financial developments for the cost and availabilty of credit, and thus for the broader economy, remain uncertain”.

Translation: Helicopter Ben is thinking about cutting the Fed's benchmark interest rate even more to stoke the economy.

Interestingly enough, long-term interest rates haven't actually fallen much since Uncle Ben got up in his whirly bird and showered the nation with money back in September.

Here's what the 30 year fixed mortgage looks like over the last six months:



30 year fixed mortgage rates are tied to the bond market, not the Fed's benchmark rate, so Ben and Company do not directly influence the rates, but you'll notice that if you were trying to get a 30 year fixed mortgage or transition from an adjustable rate mortgage to a 30 year fixed, you would have gotten much better rate back in May than you will now. And while it's true that rates fell right after the September FOMC meeting and Uncle Ben's 50 bps rate cut, you'll notice how they have inched up again since.

Now some ARM rates are tied to the Fed's benchmark interest rate, so ARM rates have fallen from about 6.2% to 5.85% now. That surely helps some adjustable rate mortgage holders with resetting payments. But overall, interest rates have not fallen as much as the Fed seems to want, which means more cuts may be in the pipeline.

The problem now becomes, how long can the Fed keep cutting rates or keep them at this level? Bloomberg News reports today that the European Central Bank sees inflation as an increasing problem and may have to raise rates before the year is out:

Oct. 17 (Bloomberg) -- European Central Bank council member Klaus Liebscher said the bank remains focused on ``significant'' and rising inflation risks, suggesting it may still raise interest rates.

``The message was and is that risks to price stability are clearly pointing to the upside,'' Liebscher, who also heads Austria's central bank, said in an interview in Vienna yesterday. ``There are significant upside risks'' and ``rising oil prices are also increasing these risks to price stability.''

The ECB on Oct. 4 left its key rate at 4 percent after shelving a planned increase in September to assess how the U.S. housing slump and rising credit costs will affect the economy. At the same time, inflation breached the ECB's 2 percent limit for the first time in more than year last month and oil prices yesterday rose above $88 a barrel.

``We'll probably see inflation accelerate to 2.7 percent by November following the surge in oil prices,'' said Holger Schmieding, chief European economist at Bank of America in London. ``We can't rule out'' a rate increase in December.

Here in the U.S., light, sweet crude hit $88.20 before closing at $87.61. With Russian President Putin threatening the U.S. over Iran, with the Turks and the Kurds at each other's throats near a significant oil route, and with oil stocks lower than expected lately, the price of oil looks like it will hit $100 a barrel before the year is out.

This means higher gas prices at the pump and higher heating costs at home.

This means higher food costs as producers transfer transportation and other energy costs off to the consumer.

This means inflation.

Now of course Uncle Ben and his merry helicopter pilots tell us that headline inflation means nothing and only the core inflation numbers (stripped of food and energy costs) mean anything.

But you'll notice every time you go to fill up your car, pay your heating bill or buy food that costs are up and you're are paying more per purchase.

Ben can keep cutting rates to try and help the banks and housing market recover from problems, but he surely risks stoking not just economic growth but 70's style inflation.

Think about the parallels between the late 60's/early 70's and now - high oil and commodity prices, high government debt, and we're fighting a war on credit.

I better get my WhipInflationNow button out of the closet.