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Cloud Call Center Community Featured Article

TMCNet: Fed slashes interest rate by a half percentage point

[September 18, 2007]

Fed slashes interest rate by a half percentage point

(Chicago Tribune (KRT) Via Thomson Dialog NewsEdge) WASHINGTON _ The Federal Reserve's dramatic reduction in interest rates on Tuesday signaled its growing concern that the economy could be brought down by a crisis in the credit markets that has put a stranglehold on the housing industry and stifled corporate borrowing.


Slashing its benchmark interest rate by a half percentage point to 4.75 percent, the central bank guaranteed easier credit conditions across the economy, with immediate help for many Americans. And there could be more interest-rate cuts in the future, the Fed hinted.

Home equity loan rates will go down along with short-term rates on automobile and other consumer loans. Many, but not all, Americans who took out adjustable-rate mortgages will see a lower rate when their loans "reset" over the next few months, according to John Silva, chief economist at Wachovia Securities.

The cut will also help relieve tight credit conditions across the economy, although it may not totally solve the credit crunch that began in the so-called "subprime" mortgage markets for marginally qualified buyers. This crunch spread to other credit markets this summer and threatened to drive the economy into a recession. The Fed cited a worsening housing correction as one phenomenon it hoped to temper with a rate reduction that will make all purchases with borrowed money less expensive.

Chairman Benjamin Bernanke's Fed approved a similar reduction in its discount rate to 5.25 percent, so that banks having a hard time getting credit could borrow directly from the central bank at a lower rate. In some areas, such as Cleveland, banks have turned to the "discount window" for loans. The Fed had made a similar cut in the discount rate in August.

But this may not be the end of reductions. The Federal Open Market Committee, the central bank's policymaking arm, cited the "uncertainty surrounding the economic outlook" in its statement. In the future, the committee said it would act "as needed" to foster price stability and "sustainable economic growth."

Though any Fed action takes some time _ from six months to a year _ to have a real impact on economic growth, the central bank will pump billions more into the U.S. economy in hopes of improving confidence in an economy that has already slowed sharply.

It wants to prevent consumers from scaling back their spending because of declining investment portfolios that might be triggered by a continuing credit crunch. And it wants to ensure that companies don't cut back on investment and job creation, vital to keeping the economy afloat.

Corporate dealmaking also could get a boost, if banks and other lenders begin to feel more comfortable funding mergers and acquisitions. The size of its first interest rate cut since 2003 surprised and pleased both Wall Street and Main Street. Stock prices surged, with the Dow Jones industrial average soaring 335.97 points, a 2.5 percent gain for the day.

But ironically, the central bank does not directly control long-term interest rates, such as those for mortgages, which go up and down according to market conditions and the rate of inflation. After its decision, the 10-year Treasury bond went slightly higher, a sign that the bond market is still wary of future inflation. Analysts said the prospect of lower mortgage rates is not clear at the moment.

"Inflation risks remain," the Fed declared in its statement in what some saw as a hedge to its signal that there could be more interest-rate cuts in the future. The central bank "will continue to monitor inflation developments carefully," it said.

"The real question is what happens to housing," said David Wyss, chief economist for Standard & Poor's, the credit-rating agency, noting the Fed is trying to limit the correction with its moves. The central bank will be watching both consumer and business spending "very closely" over the next few months, he said.

Most economists expect more interest-rate decreases in upcoming meetings, with some saying that by the end of the year, the central bank could cut its benchmark "federal funds" rate to 4.25 percent. This interest rate, which banks charge each other for overnight lending, sets the base for all other short-term interest rates.

"I think they wanted to get ahead of the game," Silva said. "It shows that they are concerned about the credit markets' problems leading to economic weakness."

(EDITORS: STORY CAN END HERE)

Andrew Stenwall, chief investment officer at Nuveen Investments in Chicago, said he expected several more reductions over the coming months as the Fed tries to deal with the prospect of a slowing economy and tight credit conditions. The federal funds rate, in the end, could be closer to 4 percent, he said.

Concerns about a recession have risen since the last Federal Reserve meeting in August, when it refrained from cutting interest rates, much to the dismay of financial markets.

Bernanke, criticized for being indecisive and too academic in comparison with his predecessor, Alan Greenspan, showed that he had a flair for the dramatic, too. When the number of payroll jobs declined in August, it gave Bernanke the evidence he needed to act to deal with a slower economy.

To some in the financial markets, Bernanke proved his mettle with the interest-rate reduction and showed he was on top of the situation _ an important psychological moment for the Fed chief in the same week that Greenspan was in the news hawking a new book on his life.

(EDITORS: STORY CAN END HERE)

The Fed's statement was clear. "Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally," the Federal Reserve's statement said.

"Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time," it said.

Timothy Opiela, an economics professor at DePaul University, said he was surprised by the size of the cut. "It seems that the Fed is worried about the probability of a recession," he said, and apparently less concerned about the direction of inflation at the moment.

But Joel Naroff, a Holland, Pa., economic consultant, said the Fed's mention of a continuing inflation risk was "a warning that the markets shouldn't assume that additional rate reductions are baked in the cake."

___

(c) 2007, Chicago Tribune.

Visit the Chicago Tribune on the Internet at http://www.chicagotribune.com/

Distributed by McClatchy-Tribune Information Services.

_____

GRAPHIC (from MCT Graphics, 202-383-6064): 20070918 FED rates

For reprints, email tmsreprints@permissionsgroup.com, call 800-374-7985 or 847-635-6550, send a fax to 847-635-6968, or write to The Permissions Group Inc., 1247 Milwaukee Ave., Suite 303, Glenview, IL 60025, USA.

Copyright 2007 Chicago Tribune

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