With inflation monster tame, Fed can manage risk

CHICAGO (Reuters) - With inflation pressures relatively tame for now, the Federal Reserve appears to have a wide-open window to pursue a "risk management" interest rate policy that insures against a steep economic downturn created by the housing market slump.

Recent mild inflation data has been applauded by policy-makers, and even as the dollar sags and crude oil prices climb many Fed watchers guess that inflation will stay contained by anemic economic growth.

"The cost of cutting with regard to inflation risk is low, but the cost of doing nothing in terms of economic growth may be high," said Cyril Beuzit, economist at BNP Paribas.

The Fed's Open Market Committee meets Tuesday and Wednesday to decide its next move. In September, the central bank surprised markets with an aggressive 50 basis point cut in the federal funds rate, its first in more than four years. That took the key lending rate to 4.75 percent from 5.25 percent.

Financial contracts handicapping expectations on Fed rate policy show a one-quarter basis point rate cut is fully priced for the upcoming meeting, with another half-point move not out of the question.

Fed Chairman Ben Bernanke is thought to favor the increased "juice" that the bank can get from markets if it does more than simply match expectations with policy moves.

With that in mind, a significant minority of bets has been placed on a 4 percent fed funds rate by year end, or 75 basis points in cuts at the next two FOMC meetings.

Deep into the quarterly earnings season, businesses such as freight-hauling companies are keeping up a drumbeat of talk about recession as the residential housing slowdown drags consumers to the ground.


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