Fed Cuts Discount Rate to 8-Year Low of 6.5% : Move Expected to Trigger Further Reductions for Consumers on Home Mortgages, Auto Loans
The Federal Reserve Board on Friday cut its discount rate to 6.5% from 7%, and economists predicted that the move will trigger further reductions in interest rates charged to consumers for home mortgages and auto loans.
The action left the discount rate--the rate the central bank charges financial institutions for emergency loans--at its lowest level in eight years. Analysts said that a decline in bank prime lending rates is practically inevitable on Monday.
The Fed said its reduction in the discount rate, the second in six weeks, was in response to strong pressure from financial markets, where other rates have been declining sharply in recent days. Although analysts said that the action should help boost economic growth, the Fed did not cite that as a reason for its action.
Cooperative Move
The last time the Fed cut the discount rate, to 7% from 7.5% on March 7, the move was taken in cooperation with West Germany and Japan.
It was later disclosed that Fed Chairman Paul A. Volcker initially had been on the losing side of an earlier 4-3 vote in favor of a unilateral rate cut. But one member of the Fed’s board changed his mind before the decision was announced, allowing Volcker time to work out a coordinated rate cut with the other nations to avoid a sharp drop in the value of the U.S. dollar.
The Fed decision this time was made on a 4-1 vote with Volcker in the majority. Outgoing Fed Vice Chairman Preston Martin and Fed governor Martha R. Seger, who led the rebellion against Volcker earlier this year, did not participate in the vote. Fed governor Emmett J. Rice opposed the move.
The Fed’s latest discount rate cut, which was widely anticipated, immediately set off speculation that another rate cut is in the offing. But economists were sharply divided over whether the Fed would engineer another step downward in the near future.
Several analysts predicted that the Fed would avoid further cuts because Volcker might be afraid of overstimulating an economy that finally appears to be rebounding after a nearly two-year period of weak growth.
“There’s no reason to pull away the punch bowl when the party’s getting good,” said Roger Brinner, a senior economist at Data Resources Inc. in Lexington, Mass. “But there’s no reason to pour any more booze in it, either.”
Others, however, said they expect the Fed to cut the discount rate to 6% in several weeks. “The market is already anticipating another rate cut,” said Daniel Van Dyke, a vice president at Bank of America in San Francisco and head of its U.S. economic forecasting unit. “In the face of declining inflation and lower (long-term) bond yields, the pressure will become irresistible.”
‘Technical Change’
The Fed called the move “a technical change” aimed at placing “the discount rate in more appropriate alignment with the prevailing level of market rates.” The statement said that the change “appears consistent with international interest rate considerations.”
Meanwhile, the Bank of Japan announced that it will cut the official discount rate by half a percentage point to a record low of 3.5%, effective Monday. The central bank’s announcement said the interest rate cut is aimed at bolstering domestic economic activity.
“This is part of a trend worldwide to lift growth through easier monetary policy,” said Allen Sinai, chief economist at Shearson Lehman Bros., a New York investment firm. “I think we’re going to see more efforts to coordinate policy on an international basis.”
Little Inflation Danger
With oil prices staying low, analysts argued that declining interest rates--designed to stimulate economic activity by encouraging additional borrowing and spending--carry little danger of reviving inflation at this stage in the economic expansion.
“This is economic chicken soup,” said Irwin Kellner, chief economist at Manufacturers Hanover Bank in New York. “Lower interest rates are good for everybody right now.”
Prime Rates Cut
When the Fed cut its discount rate last month, banks immediately reduced their prime lending rates to 9% from 9.5%. The prime is a benchmark used to figure interest costs on a wide variety of loans with fluctuating rates, primarily business borrowings but also some types of consumer loans.
Other short-term money market rates, such as those on three-month Treasury bills, have fallen as low as 5.9% recently.
Wide anticipation of the latest cut set off huge rallies earlier this week in the stock and bond markets. It was also a big factor behind this week’s decline of the U.S. dollar, which set another postwar low against the Japanese yen on Friday and fell sharply in relation to most other major currencies.
If the dollar continues to weaken, some analysts warned, the Fed might have to bring a halt to the decline in interest rates.
“The exchange markets could be a factor in preventing a further discount rate cut,” said Jerry Jordan, chief economist at First Interstate Bank in Los Angeles. “But as long as the Fed governors can cut (short-term interest) rates and the dollar doesn’t go into a free fall, they will probably continue to do so.”
