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By BRIAN BLACKSTONE and HENRY J. PULIZZI
October 31, 2007 2:22 p.m.
WASHINGTON — The Federal Reserve on Wednesday cut its key lending rate for a second-straight month to fend off a housing-induced economic downturn.

[fed funds]

But in an accompanying statement officials signaled that growth and inflation risks are “roughly balanced” and policy action to date should help the economy, suggesting future rate reductions are by no means as assured as Wall Street thinks.

The Federal Open Market Committee, as widely expected in a Dow Jones Newswires poll, voted 9-1 to cut the federal funds rate, the rate at which banks lend to each other, by 25 basis points to 4.5%.

Kansas city Fed President Thomas Hoenig dissented, preferring no rate change. Last month the Fed reduced the funds rate for the first time in over four years, by 50 basis points.

The Fed also lowered the discount rate it charges banks that borrow directly from the Fed by one-quarter point to 5%. It has reduced the discount rate 125 basis points since August to alleviate strains in short-term credit markets.

“Today’s action, combined with the policy action take in September, should help forestall some of the adverse effects on the broader economy” from financial disruptions, the FOMC said in a statement. Last month, the Fed said its rate cut was “intended to help forestall” the effects of financial market disruptions on the economy.

Prior to Wednesday’s decision and statement, financial markets priced in strong odds that the Fed will lower the fed funds rate to as low as 4% in 2008.

But the reference to September’s cut suggests officials may not see the need for future cuts. Indeed, that type of reference has signaled an end to easing cycles in the past. In November 1998, the Fed referred to “the 75 basis point decline in the federal funds rate since September” and didn’t lower it further in that cycle.

The Fed also said inflationb and growth risks are roughly in balance. To be sure, more rate cuts remain possible with housing showing no signs of stabilizing, and the Fed said it will “act as needed” to foster growth and stable inflation.

Yet there’s little evidence so far that the economy has slowed much. Gross domestic product swelled at a 3.9% clip last quarter, the Commerce Department said Wednesday, as resilient consumer spending and robust exports offset another big housing drag.

GDP advanced 3.8% in the second quarter, putting the Fed in the awkward position — from a communications standpoint at least — of cutting rates twice even though the economy has grown well above its noninflationary potential of a little less than 3% over the past six months.

“Economic growth was solid in the third quarter,” the Fed said.

But it’s the fourth quarter and early 2008 that worry officials. As Bernanke noted in an Oct. 15 speech, housing will likely be a “significant drag” into next year and “the housing correction and tighter credit conditions could presage broader weakening in economic conditions that would be difficult to arrest.”

Forecasters think the economy will grow in just the 1% to 2% range this quarter, and the Fed said growth will likely slow in its statement.

Initial jobless claims have been above 330,000 for two-straight weeks, a sign that labor markets have weakened further after tepid employment gains in August and September. Consumer confidence has also fallen, as have existing home sales, housing starts and home prices, suggesting downside risks to consumer spending, which makes up two-thirds of GDP.

Meanwhile, core inflation as measured by the Fed’s preferred gauge, the price index for personal consumption expenditures excluding food and energy, remains within the Fed’s assumed comfort zone at 1.8% annual growth through August. September data are due Thursday. Labor costs remain tame.

Yet the Fed continued to warn that inflation risks remain, citing energy and commodity prices.

Copyright © 2007 Dow Jones & Company, Inc. All Rights Reserved

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