Fed Cut Signals Recovery Not at Hand.

THE Federal Reserve's half-point cut in its benchmark interest rate last week shows the central bank has joined the pessimists who expected the economy to remain sluggish far longer than first thought.

That may have been hard to discern before the April 18 rate-cut announcement. As late as last week, top Fed officials had been conspicuously upbeat. Some even predicted that the economy would begin expanding visibly again early in the second half.

"I think that nationally things aren't super, but they aren't as bad as what many people are saying," William Poole, president of the Federal Reserve Bank of St. Louis, said only two weeks ago. "I think we're going to be growing from here on out."

Such cheerleading came mainly from the more vocal regional Fed bank presidents, not from Fed Chairman Alan Greenspan or from the four other members of the central bank's board of governors.

What last week's action showed was that top Fed policymakers now think the quick rebound they expected only a few weeks ago no longer is likely, and the recovery may not come in earnest until the end of 2001 or sometime in 2002.

"The Federal Reserve was apparently concerned that the economic recovery might not be taking place," said Lynn Reaser, senior economist with Bank of America Capital Management Inc. in St. Louis.

No deep recession

That doesn't mean the central bank is worried the economy will fall into a deep recession. As the Fed pointed out, there's continuing strength in some parts of the economy. And the inventory glut that once threatened the economy has disappeared.

The difficulty is that several other elements in the economic picture either have deteriorated or haven't begun to bounce back: Consumer spending seems poised to slow. Computer-related firms still are in trouble. Capital spending is weak.

Policymakers had been moving cautiously in recent weeks to see where the economy was headed. The end of the inventory glut had pleased them, but they were uncertain about business and consumer spending. New data resolved that -- with a jolt.

"(The Fed's rate cut) is an insurance policy," said Wayne Ayers, chief economist at FleetBoston Financial Corp., noting that the cut came 27 days ahead of the Fed's scheduled May 15 meeting. "The economic news is bound to get worse before it gets better."

Activist Fed

For the Fed, last week's surprise action also marked a return to the sort of activist posture that the central bank embraced when it was trying to slow the economy early last year and in late 1999.

The Fed has been essentially reactive in recent months -- moving primarily in response to developments in the economy, rather than to anticipate them. And it has been criticized roundly for having been behind the curve.

This time, however, the ction, surprising them with a stunning performance that analysts said showed that Greenspan and his colleagues once again are firmly at the helm.

"I think the Fed has made it pretty clear that they're not pushing on a string and that they can respond in a way that will jolt the market," said James Glassman, senior economist at J.P. Morgan Chase & Co.

Many analysts are expecting a second rate-reduction when the Fed meets on May 15, but the effect of that cut or the one last week won't be felt for months.

Psychological effect

Yet, the biggest effect may be psychological -- and that's just as important. Glassman says: "This kind of action calms down the talk about recession, and could really turn sentiment around, both for businesses and for consumers."

That, in turn, may spur more investment by lowering borrowing costs for business and consumers -- a development that might improve corporate profits and have a wide effect on the economy.

As might be expected, the shock treatment sparked an outsized rally in the financial markets. The Dow Jones Industrial Average soared more than 400 points within a half-hour after the Fed's announcement. The Nasdaq Composite Index also rose.

Still uncertain is what effect the cut might have on the value of the dollar. After a brief surge, the dollar fell against the euro after the Fed's announcement on concern that the U.S. economy is weaker than many forecasters had thought.

In any case, the message last week was that the Fed has come to the conclusion that the economy is doing somewhat worse than expected and is willing to try to do something to bolster it.

"My guess is that we'll look back and remember this as an important turning-point," Glassman said.

Art Pine is a columnist for Bloomberg News.