Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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If the economy were a contestant on one of those weight loss reality shows, it would be in terrific shape now. But the economy isn’t a weight loss contestant (though its losses are impressive) and it certainly isn’t in good shape. The challenge for journalists is finding words to describe depths few have seen.

How many times have you heard or read these phrases in the past few weeks: “Record low.” “A new low point.” “Slowest pace since record-keeping began.” It was definitely more fun to talk about records during the boom – a term that hasn’t been mentioned much of late, except in the past tense.

In the present tense, the economic indicators continue to point south. The growth rate turned negative in the fourth quarter, declining at an annual rate of 3.8 percent and reducing the GDP for the year to 1.3 percent – the slowest pace (here we go) since 2001. The unemployment rate hit 7.2 percent in December as the nation lost more than 2.6 million jobs for the year, pushing unemployment claims to a 26-year high and straining state unemployment insurance funds. The National Employment Law project reports that five of those funds have run out of money and another 13 are at “major risk” of following suit.

Consumer confidence, not surprisingly, has continued to decline, taking consumer spending down with it. The Commerce Department reported that consumer spending increased by only 3.6 percent last year – the smallest gain since 196. Putting a statistical exclamation point on a cheerless holiday season for retailers, spending declined for the sixth consecutive month in December.

Savings rates, moving in the opposite direction, increased to 1.7 percent of after-tax income in December from a low of 0.4 percent in 2005, indicating that consumers “are in a mood to rebuild their savings, but not to go out and spend,” Mark Vitner, an economist at Wachovia, told CNN-Money. Normally, he noted, “that’s a good thing, but not when everyone does it at the same time.”

Weakness Across the Board

The Federal Reserve’s most recent Beige Book report found weakness across the board in every economic sector and geographic region. The Fed’s survey of senior loan officers, meanwhile, confirmed what the media has been reporting – despite government efforts to recapitalize financial institutions, loan volume and loan demand are still declining. More than 65 percent of the lenders surveyed reported that they have tightened standards for commercial and industrial loans, 45 percent said they have tightened up on residential mortgages as well, and the same proportion (45 percent) said they have reduced credit limits for new or existing credit card customers. Of the 53 domestic banks and 23 foreign institutions surveyed, none said they had eased standards in any loan category.

Under continuing fire from legislators for failing to use some of the $350 billion banks have received thus far in federal TARP funding, some lenders have fired back, blaming regulators for tying their hands by forcing them to set aside ever increasing sums against possible future losses. Bankers say they are getting mixed messages, with legislators telling them to pump money out and regulators insisting that they build capital ratios up. “Two arms of government are saying exactly the opposite think – it’s ridiculous,” Greg Melvin, a board member at FNB Corp. in Pennsylvania, complained to an Associated Press reporter.

Regulators say they aren’t discouraging lending, only insisting on prudent lending policies. “We don’t believe that prudence and increased lending are mutually exclusive; they go hand in hand,” Andrew Gray, a spokesman for the Federal deposit Insurance Corporation (FDIC) told AP.

Good, Bad, and Awful

In the housing market, recent reports provide good news and bad. The good news: Declining home values have reduced the affordability gap between incomes and home prices. The bad news: The souring economy has reduced the number of people with the incomes, confidence, or both required to purchase homes. One industry analyst offered this simple summary of the housing market’s continuing problems: “Too many homes for sale, too few buyers, and too much uncertainty about the outlook for home prices and the economy.”

The housing statistics aren’t entirely negative. Existing home sales actually increased by 6.5 percent in December, reducing the bloated inventory of homes for sale from more than 11 months to 9. Pending sales also increased for the first time in four months, as buyers apparently responded to bargain prices and attractive interest rates.

No one is getting terribly excited about those numbers, however, among other reasons – because interest rates, which had been declining, have begun to tick upward again, and, even more, because nearly one third of the December sales involved foreclosures or “short sales” on which lenders allowed underwater owners to accept less than the outstanding principal balance on their mortgage.

If the home resale market is a mess – a description few would dispute — the new home market is a train wreck. Sales of new homes fell by another 15 percent in December, reaching their lowest level since 1963 and expanding the for-sale inventory to nearly 13 months. Home starts fell by 16 percent in December to their lowest level since the Commerce Department began tracking this indicator in 1959, while construction spending generally tanked.

A Vicious Cycle

Foreclosures, which are boosting inventories and further depressing home prices, soared by 81 percent last year, according to RealtyTrac, which estimates that 1/54 households received foreclosure notices .

“Foreclosures increase the inventory and depress prices, producing more foreclosures and further depressing prices – the vicious cycle continues,” Stan Humphries, a vice president at, told CNNMoney. Zillow estimates that the housing market lost an aggregate total of $3.3 million in value last year, leaving 1/6 owners with homes worth less than their mortgages.

Housing industry executives are pinning their hopes for recovery in large part on government efforts to curb foreclosures and encourage home buying activity. “Clearly, conditions in the nation’s housing market aren’t getting any better, and they aren’t going to get any better until the federal government takes substantial action to encourage buyers to get back in the market,” Sandy Dunn, chairman of the National Association of Home Builders, said in a recent press statement.

It appears likely that the economic stimulus bill – political sausage still in the making in Congress – will include a tax credit for home buyers and funding for foreclosure modifications, but how much relief these and other initiatives will provide, and how quickly, remains unclear.

Desperately Seeking Optimists

In the meantime, optimists are becoming something of an endangered species, even among those programmed genetically or politically to be upbeat. The NAHB’s builder confidence survey has been depressed for so long it may have to be renamed. Analysts at the National Association of Realtors (NAR), who normally seize on the tiniest positive number as evidence that a rebound is at hand, downplayed the recent increases in pending and existing home sales, commenting instead that housing market conditions remain “far from normal and balanced.”

In its most recent commentary, the Fed’s Federal Open Market Committee acknowledged “significant risks” that the “gradual recovery” it has forecast beginning later this year may not materialize. An even more pessimistic Price Waterhouse survey reported “deepening despondency” among corporate CEOs surveyed last month. “Although business confidence was already in decline a year ago,” this report said, “the spread with which anxiety levels have soared, particularly since mid-September [of last year] is dramatic.”

The only marginally upbeat assessment we could find came from Wall Street Journal columnist Mark Gonsloff, who observed, “Things are still getting worse, but possibly at a slower pace.”

“There is a bottom out there,” Lakshman Achuthan, managing director of the Economic Cycle Research Institute, told Gonsloff. “But it may be lower than you think.”