Merrill Lynch has reduced its expectations for the next US Federal Reserve Board decision, it now anticipates just a 25 basis point reduction.

“Revisions to our interest rate outlook are akin to some light spring cleaning, as they do not represent major changes to our view,” the firm says in a research note. “We still look for the Fed to eventually cut the funds rate to 1% as it deals with the intensifying credit crunch, continued decline in home prices and an unfolding economic recession. We still hold an out-of-consensus view that 10-year yields will dip below 3% in 2009, as the economic rebound in 2009 will be disappointingly modest.”

However, it now expects the pace of Fed easing to slow. It has pared back its expectation for the rate cut at the upcoming FOMC meeting on April 29/30, to 25 bps from 50 bps previously. “After two dissents at the last FOMC meeting, it is not clear that there will be enough support for a 50 basis point move,” it says.

“Beyond April, the Fed may not necessarily ease at every meeting and in fact we anticipate that the Fed will be easing by a reduced pace of 25 bps per quarter in 2Q and 3Q 2008,” it adds.

“The Fed acknowledged in the March FOMC minutes that real GDP was going to contract moderately in the first half of the year, but we must be sensitive to the fact that the 200 bps of easing so far in 2008 was aimed exactly at that development. Since it looks like 1Q real GDP will be close to flat, a 2Q negative growth rate would not likely surprise the Fed,” Merrill says. “And, we do have the fiscal stimulus in May, and the Fed may not want to move too aggressively ahead of this. It may want to adopt a wait-and-see approach to gauge how much of the stimulus is spent.”