Fed Sees Rate Low `for a Time’ Then Possible Reversal (Update1)

by Scott Lanman

(Bloomberg) Federal Reserve officials signaled they are prepared to quickly reverse last month’s interest-rate cuts after concluding that borrowing costs need to be kept low for now.

Policy makers cut their 2008 growth forecasts and said that rates should be held down “for a time,” minutes of their Jan. 29-30 meeting showed yesterday. They also called inflation “disappointing,” and some foresaw raising rates, possibly at a “rapid” pace once the economy recovers.

The threat goes beyond remarks by Chairman Ben S. Bernanke, who last week warned that policy will have to be “calibrated” over the next year to meet both inflation and growth objectives.

Yes, the issue is they believe an output gap greater than ‘zero’ is required to bring down inflation over time; so, they can’t afford to let the economy fully recover and grow at an inflationary pace.

So while they don’t want to allow a massive collapse, they also don’t want the output gap to be too narrow to bring down inflation.

This could mean, for example, a GDP growth rate speed limit of between 1% and 2% given current data points of GDP growth and coincident inflation.

That would mean achieving ‘stability’ at current GDP and employment levels rather than a ‘recovery’ to lower unemployment and 2.5%+ GDP.

With inflation expectations considered to be on the verge of elevating, the FOMC now faces elevating risks of both inflation and recession.