Economy may need new rate cut

The US economy has slowed enough in the past few weeks that the Federal Reserve may move to cut interest rates – perhaps by as much as half a percentage point – when it meets next week.

At a slower pace, the economy is more vulnerable to extraneous events. An unexpected spike in oil prices or a 1,000-point stock market drop may be enough to push America back into recession next year.

The fresh economic worries come despite news yesterday that gross domestic product grew by 3.1 percent, about twice as fast as the prior quarter. The economy was spurred largely by Americans visiting car lots to take advantage of cut-rate financing. But the GDP numbers were a bit slower than expected, and economists don't think sales at car dealerships kept the same pace in October.

"The momentum has weakened significantly in the last couple of weeks," says Sung Won Sohn, chief economist at Wells Fargo Banks in Minneapolis.

Behind the slowdown is lagging confidence, driven by talk of war and by a continuing tide of lay-off announcements.

As a result, consumers are finally pulling back from the car and homebuying binge. This caution is expected to continue through the holiday period, resulting in relatively lackluster sales. And business, uncertain about the economy and perhaps waiting to see if Congress gives it inducements, is slow to invest in new equipment, plants, and people.

With neither consumers nor business pulling out their wallets, economists believe the Federal Reserve will have to provide new stimulus – either a quarter- or half-point cut in short term interest rates.

"To be effective, monetary policy must have some element of surprise, so a half a point is more effective than a quarter of a point," says Mr. Sohn. "Otherwise, the Fed may be wasting its ammo."

The economy is slowing just as Americans get ready to vote in state and congressional elections. Still, though most Americans list the economy as a major concern it's not expected to play a large part in the election. "The economy is usually not so much of an issue for the mid-term as it is for presidential elections," says David Wyss, economist at Standard & Poor's in New York. "Voters tend to hold the president responsible, not Congress."

Even in areas where the economy is weak, it has not become part of the political debate. Take Philadelphia, where the unemployment rate is 7.9 percent and has been high for some time. None of the three Democratic congressmen from the city faces a serious challenge, and the state of the economy is not part of the campaign.

"I think a lot of people in Philadelphia are convinced that all is being done that can be done," says Dave Bartelt, chair of the geography and urban studies department at Temple University there. "It's like shoveling sand against the tide."

The local economy has also been bad in California's Central Valley, where unemployment is between 12 and 13 percent. Family farms are going under and banks are reluctant to make new loans. Despite the tough times, however, the economy has not been an issue in the area's congressional races. "Water and healthcare have been the main issues," says Joseph Penbera, a professor of business at California State University in Fresno.

Nationally, the economy is in better shape but starting to show some signs of fraying. Today, the government will report the October unemployment rate, which is expected to rise to 5.8 or 5.9 percent, up from 5.6 percent in September. Traditionally, the unemployment rate has risen at the end of the year. "Companies find they are not going to meet their optimistic projections so they are forced to cut costs," says John Challenger of the Chicago outplacement firm Challenger, Gray and Christmas.

Rising unemployment will not help consumer spending. This week, the Conference Board reported that its consumer confidence numbers dropped sharply as American pessimism rose – both for the short term outlook and for the future. "It signals a slowing in spending, but how slow remains to be seen," says Lynn Franco, an economist with the Board, a business research group in New York.

In fact, the National Retail Federation still expects holiday sales to grow by 4 percent this year. "Last year consumer confidence stank, and holiday sales rose 5.6 percent," says Scott Krugman, a spokesman for the Washington-based group. "We find low consumer confidence can be combated with a very good sale, and consumers are going to be seeing a lot of great sales this season."

The last time the confidence surveys dropped this quickly was in August and September 2001, or just before the economy moved into a recession. Although economists are still not predicting another downturn, they say warning bells are sounding. "Consumers won't provide the cushion for the economy if business investment does not come back," says Richard Curtin, director of consumer surveys at the University of Michigan.

There are some signs that business is starting to spend more, says Daniel Meckstroth, chief economist for the Manufacturers Alliance/MAPI in Arlington, Va.

Orders for new computers and software are rising. But investment in new structures has fallen dramatically. For the most part, businesses remain cautious. "I had thought capital spending would rebound in the Fourth quarter," says Mr. Meckstroth, "but now ... I think it will be rather weak into next year."