Federal Reserve policymakers face a moment of truth Tuesday as they meet on interest rates amid a sputtering economy, but with some arguing against a return to easy-money conditions blamed for the problems. The Federal Open Market Committee, set to announce a decision at 1815 GMT Tuesday, is widely expected to cut interest rates in a bid to ease stress in the housing and credit markets, and head off a potential recession.

Most analysts say they expect the FOMC, which has held its federal funds rate at 5.25% since June 2006, to cut the benchmark rate by 25 or 50 basis points, which could lead to lower borrowing costs for many consumers and businesses. A rate cut "would reflect an effort to contain the downside risks to growth associated with the swift tightening in financial conditions this summer in an already subpar economy," said Citigroup economist Robert DiClemente, who predicts a half-point cut.

DiClemente says the current rate of 5.25% is "higher than neutral," or holding back economic growth, and that a failure to cut rates "could risk an undesirable breach in investor confidence and broader damage to the expansion."

"The sooner we get to 4.5 percent or thereabouts, the better the chances of stabilising the economic outlook and the financial system that supports it," DiClemente said.

Some analysts say that if the Fed fails to take bold action such as a half-point cut, it could trigger more turmoil in financial markets, causing more failures of home lenders and mortgage defaults and prompting a freezing up of broader credit markets. "We strongly believe that if the Fed only cuts rates by 25 basis points even with a strongly worded FOMC statement to commit to more easing if need be, there could be a significant disappointment trade in the financial markets, especially in stocks," said Deutsche Bank economists Joseph LaVorgna and Carl Riccadonna in a note to clients.

"If policymakers move too slowly now, they run the risk that more considerable damage will be inflicted on the financial markets and the real economy, and resultantly they will have to cut rates more aggressively in the long run." Others claim that economic conditions do not warrant a rate cut, and that such a move would simply be providing more of the easy money that fuelled the boom-and-bust cycle.

Fed Chairman Ben Bernanke said late last month the central bank stood ready to act as necessary to limit damage to the broader economy from the housing slump and turbulence in credit markets nervous about a wave of mortgage delinquencies. Bernanke's remarks were seen as opening the door to lower rates and a report on August 7 showing the economy shed jobs in August for the first time in four years was seen as cementing the case for cutting overnight borrowing costs from their current 5.25 percent level.

The only question remaining seemed to be how large a reduction may be in store. Through last week, interest rate futures markets showed investors saw a somewhat greater probability of a half-percentage point cut in the overnight federal funds rate than a quarter-point.

The Fed futures contracts continue to show 100% probability of 25 bps cut. Fed futures contracts show 50% probability of 50 bps cut vs 58% day before. A discount rate cut (currently at 5.75%) is also on the Fed's table.

FED FOCUS
Probability Table
Sep 11: 100% for -25 bps Vs 72% for -50 bps
Sep 12: 100% for -25 bps Vs 74% for -50 bps
Sep 13: 100% for -25 bps Vs 58% for -50 bps
Sep 14: 100% for -25 bps Vs 58% for -50 bps
Sep 17: 100% for -25 bps Vs 50% for -50 bps
Sep 18: FOMC decision on federal funds target rate

6 out of top 21 primary dealers are indicating 25 bps fed rate cut, while others 50 bps. 10 out of top 21 primary dealers are indicating 50 bps discount fed rate cut. 7 out of top 21 primary dealers are indicating 25 bps discount fed rate cut.

List of the primary dealers and their forecasts for what the Fed will do with its target and discount rates today:

Firm	Fed Rate	Discount Rate
Citigroup	4.75	5.25
Countrywide	4.75	5.25
HSBC Securities	4.75	5
Deutsche Bank	4.75	5.25
Goldman Sachs	4.75	5
Merrill Lynch	4.75	5.25
BNP Paribas	5	5.5
Banc of America	5	5.25
Barclays Capital	5	5.25
Bear Stearns	5	5.5
Cantor Fitzgerald	5	5.25
Credit Suisse	5	5.25
Daiwa Securities	5	4.5
Dresdner Kleinwort	5	5.5
Greenwich Capital	5	5.25
J.P. Morgan	5	5.5
Lehman Brothers	5	5.5
Mizuho	5	5.75
Morgan Stanley	5	5.5
Nomura Securities	5	5.5
UBS	5	5.25