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. Last Updated: 07/27/2016

All Eyes on Fed Ahead of Key Meeting

WASHINGTON -- U.S. Federal Reserve officials are widely expected to keep interest rates at 40-year lows when they gather Tuesday, but a loss of economic momentum has raised prospects the central bank could lower rates later this year to make certain the recovery doesn't stall.

Just a few weeks ago, the economy seemed on a clear, if weak, recovery path. But some recent data has shown the path to be rocky indeed, fueling hopes the central bank will eventually ride to the rescue by lowering borrowing costs further.

"This is a difficult time because it's not clear. You're not on a clear upward [economic] trend and you're not on clear downward trend," said former Fed governor Susan Phillips.

The increasingly murky outlook has uncertain markets eyeing Tuesday's meeting of the U.S. central bank's Federal Open Market Committee especially closely, looking for any sign the Fed might consider adding to the 11 rate cuts made last year.

"We're all trying to gauge how close the Fed is to pulling the trigger, and I think they're pretty close," said Dana Johnson, head of research at Banc One Capital Markets.

U.S. central bank policy-makers, who last met June 25 and 26, have kept rates unchanged since December.

A few months ago, most analysts thought rates would already be moving up by now. But the stock market's steep swoon led economists to lower growth forecasts and warn of rising risks that even those scaled-back projections could miss the mark.

A majority of economists continue to think the Fed's next move will be to push rates higher, although not until well into next year. Still, they say a rate cut this year is not unthinkable and a small minority actually expect lower rates the year's end, with a rare few looking for a cut Tuesday.

But so far, Fed officials -- including Chairman Alan Greenspan -- have shown no inclination to trim rates further. In fact, Greenspan signaled the Fed's intention to hold rates steady in testimony to Congress less than four weeks ago.

While rate-cut talk has been spurred since then by reports showing anemic second-quarter growth, little hiring and an ailing manufacturing sector, Fed officials have continued to discount the risk of renewed recession -- the so-called double dip.

"There are conflicting signs but quite frankly I still don't think there's a significant probability of what is often referred to as a double dip," San Francisco Fed President Robert Parry said earlier this month.

Most analysts say economic data would have to continue to come in weaker than expected for the Fed to cut rates.

"They are saying at a minimum, 'Lets wait and see,'" said Sung Won Sohn, chief economist at Wells Fargo Banks. "Most likely they're right, there should not be any need to cut interest rates."

Amid widespread debate on Wall Street about what the Fed might do or should do in weeks ahead, the statement announcing the FOMC's decision Tuesday at about 2:15 p.m. in Washington will be met by exceptionally intense scrutiny.

In particular, markets will look to see if the central bank has shifted its assessment of economic risks from one of balance between inflation and recession to one in which recession risks predominate.

Some analysts see such a shift as likely, but others believe it could fuel expectations for a rate cut the Fed hopes it won't have to deliver.

Still, the Fed is expected to say something to acknowledge recent weakness.

"For Federal Reserve officials not to acknowledge the change in circumstances would be risky to their own credibility, especially if the economic news continues on the soft side," Goldman Sachs chief economist Bill Dudley said in a research note Friday.

Phillips said officials likely will discuss both the economy's strengths and weaknesses in their statement, while retaining their assessment of the balance of risks.

"They'll do the classic 'on the one hand, on the other hand,'" she predicted. "The real fundamentals are not that terrible," she said, noting that housing and auto sales have been strong and overall consumer spending has held up relatively well despite the sharp stock market sell off.

But even some economists who say steady recovery is the most likely path feel the Fed may lower borrowing costs as a form of insurance in case forecasts prove overly optimistic.

They point to Japan's long battle against deflation, a widespread decline in prices that has fed a cycle of economic weakness.

Researchers at the Fed say central banks should lower rates more than economic forecasts suggest is needed when inflation is low and deflation is a risk.

"The costs of procrastinating and waiting for clearer signs of renewed recession far outweigh the potential costs from easing aggressively and soon," said Robert McGee, senior strategist at the New York branch of UFJ Bank.

Others argue that having slashed the federal funds rate to 1.75 percent from 6.5 percent over last year, the Fed already has added the necessary stimulus to keep the economy growing.

"I don't know of anybody who is not buying a house or a car because of high interest rates," Wells Fargo's Sohn said, arguing that lower rates would do the economy little good.