WASHINGTON (AP) - The Federal Reserve dropped its most important
interest rate to a nearly two-year low on Tuesday and left the door
open to additional cuts to prevent a housing and credit meltdown
from pushing the economy into a recession.
Fed Chairman Ben Bernanke and all but one of his colleagues
agreed to trim the federal funds rate by one-quarter percentage
point to 4.25 percent.
The rate reduction, the third this year, was needed to energize
national economic growth, Fed officials said. The deepening housing
slump is affecting the behavior of consumers and businesses alike,
the Fed said.
"Economic growth is slowing, reflecting the intensification of
the housing correction and some softening in business and consumer
spending. Moreover, strains in financial markets have increased in
recent weeks," the Fed said in a statement explaining its decision
to cut rates again. The three rate cuts ordered thus far "should
help promote moderate growth over time," the Fed added.
On Wall Street, stocks tumbled, reflecting disappointment among
some investors who were hoping for a larger rate cut. The Dow Jones
industrial plunged more than 200 points.
The funds rate affects many other interest rates charged to
individuals and businesses and is the Fed's most potent tool for
influencing economic activity.
In response, commercial banks, including Wachovia and Wells
Fargo, lowered their prime lending rate by a corresponding amount,
to 7.25 percent. The prime rate applies to certain credit cards,
home equity lines of credit and other loans.
The fact that the Fed's key rate was lowered again marked an
about-face for the central bank. At its previous meeting in
October, Fed officials hinted that their two rate cuts probably
would be sufficient to help the economy survive the housing and
credit stresses. Since then, however, financial conditions have
deteriorated, prompting Bernanke to signal before Tuesday's meeting
that another rate cut may be needed after all as an insurance
policy against undue economic weakness.
As another bolstering move, the Fed on Tuesday also lowered its
lending rates to banks by one-quarter percentage point. That was
the fourth cut to the discount rate since mid-August.
"Recent developments, including the deterioration in financial
market conditions, have increased the uncertainty surrounding the
outlook for economic growth and inflation," the Fed said in its
Banks, financial companies and other investors who made loans to
people with spotty credit or put money into securities backed by
those subprime mortgages have lost billions of dollars. Investors
in the U.S. and abroad have grown more wary of buying new debt,
thereby aggravating the credit crunch.
Harder-to-get credit has thwarted would-be home buyers,
intensifying the housing collapse. Foreclosures have soared to
record highs. The number of unsold homes have piled up. Problems
are expected to persist well into next year.
The 9-1 decision for a quarter-point reduction to the funds rate
was opposed by Eric Rosengren, president of the Federal Reserve
Bank of Boston. He preferred a bolder, half-percentage point cut.
"Fed's language clearly reflects a heightened degree of concern
about the economic outlook," said Carl Tannenbaum, chief economist
at LaSalle Bank. "They left open the possibility of additional
rate reductions," he added. If the economy were to take a turn for
the worse, another rate cut could come before the Fed's next
scheduled meeting on Jan. 29-30, Tannbenbaum said.
The situation poses the biggest challenge yet to Bernanke, who
took over the Fed in February 2006. Some analysts have questioned
whether he waited too long to cut the Fed's key rate and whether he
has acted aggressively enough to the nation's economic woes.
In September, the central bank dropped the funds rate for the
first time in four years. Then it was a half-point drop; on Oct. 31
came a quarter-point cut.
The rationale behind the lower rates is that they will induce
consumers and businesses to boost spending, invigorating economic
activity. With Tuesday's reductions, both the funds rate and the
prime rate are now at their lowest levels in nearly two years.
From July through September, the economy logged its best growth
in four years. But it is expected to slow to a pace of just 1.5
percent or less over the final three months of the year as the
housing collapse and credit crunch chill consumers, sapping overall
economic growth. The odds of a recession have grown.
With growth cooling, the unemployment rate, now at a relatively
low 4.7 percent, is expected to rise. Analysts expect the jobless
rate to climb to 5 percent by early next year.
High oil prices could complicate the Fed's job of trying to keep
the economy expanding and inflation low.
Oil prices, which had neared $100 a barrel, have moderated. But
they are still high. High energy prices are a double-edged sword.
They can slow economic activity and spread inflation if they cause
the prices of lots of other goods and services to rise.
"Elevated energy and commodity prices, among other factors, may
put upward pressure on inflation," the Fed said. "Inflation risks
remain," the Fed said, adding that it "will continue to monitor
inflation developments carefully." Some economists believed the
Fed's decision to go with a moderate quarter-point cut was a nod to
those inflation concerns.
On the Net:
Federal Reserve: http://www.federalreserve.gov/
(Copyright 2007 by The Associated Press. All Rights Reserved.)