Fed Acts to Cut Interest Rates; Drop Is Modest

The Federal Reserve moved swiftly to push interest rates down Monday in the wake of the budget deficit-reduction bill that Congress passed Saturday. But, as expected, the reduction was modest.

Wall Street analysts said that the Fed cut the federal funds rate--the interest rate banks charge on overnight loans--to 7.75%, a quarter of a percentage-point below Friday’s level. Although such moves often are visible in the markets, the Fed does not announce its actions.

But the interest-rate reduction was so small that analysts said it represented little more than a political gesture, fulfilling an implied promise by Fed Chairman Alan Greenspan, who had said that enactment of the deficit-reduction package would help bring interest rates down.

“The fiscal package was more of a political achievement than an economic achievement but it is credible enough to allow Greenspan to move,” said Ronald Solberg, an economist at Security Pacific National Bank in Los Angeles.

Even so, a majority of the Fed’s policy-setting Federal Open Market Committee apparently is still fearful of acting too boldly, lest the credit markets fear that the central bank is abandoning its fight against inflation--and thus push interest rates back up again.

Fed policy-makers also are concerned about the continuing decline in the value of the dollar, which exacerbates inflation pressures. They also are worried that if the dollar falls too far, the Fed may have to push interest rates up to help defend the U.S. currency.

Monday’s cut is not likely to have much of an impact on other major interest rates. Economists said that the Fed may hold off on further action to see how the economy performs over the next few weeks.

Despite the Fed’s action Monday, the Bush Administration remained silent on the issue. Treasury Secretary Nicholas F. Brady, who had pressured the Fed for months to push interest rates down to help spur the weakening economy, declined to comment on the move.

Top Fed officials have indicated repeatedly that they are wary of easing interest rates significantly for fear of allowing inflation to bolt out of control during a time when oil prices are soaring.

Both higher oil prices and the rapid decline in the value of the dollar against other currencies, which tends to make imports more expensive in this country, have added to inflationary pressures.

Some economists said that the Fed may be waiting for additional economic data--including figures due out today on the gross national product for the third quarter, as well as the October unemployment report, scheduled for Friday--to decide whether further rate cuts are needed.

“The economic reports coming out over the next week could be critical to determining whether we get a further drop in interest rates,” said Mark Wanshell, an economist at J. P. Morgan in New York. “If we don’t get data that is substantially weaker than what we have had, the Fed may become skeptical about whether the economy is as weak as people think, and they may hold off on further cuts.”

Monday’s slight reduction isn’t likely to have much of an impact on other interest rates, especially those for mortgages and consumer loans.

Analysts said that the financial and credit markets have anticipated the Fed’s action for so long--at least two months--that many other consumer and commercial loan rates already reflect the lower federal funds rate.

“This has been very well-advertised, so it is not really affecting the market today,” noted Wanshell. “Everybody was expecting that this would come this morning,” after the budget agreement, he added.

“Greenspan, for all intents and purposes, had said publicly that if you get an agreement, we at the Fed will ease,” said Stephen Axilrod, an economist at Nikko Securities in New York, and a former Fed staffer.

“The market had been expecting it for a long time, so now it is saying: ‘So what.’ ”

In fact, the stock market remains more heavily focused on oil prices and on events in the Persian Gulf than on the budget settlement.

So despite the cut in the federal funds rate, prices on the New York Stock Exchange closed slightly lower Monday, with the Dow Jones Industrial Average dropping 5.94 points, to a new level of 2,430.20. The 30-share index has fallen a combined 74.01 points since Oct. 25.

Yet, some economists remain optimistic that Monday’s action represents just the first in a series of moves toward lower interest rates that the Fed will take over the next six to nine months.

They believe that the nation has entered a mild recession, and that the economy will post declines in growth for the final three months of the year. They expect the economy to remain flat for the first half of 1990, and then turn upward by the third quarter of 1991.

As a result, many predict that the Fed will be able to cut the federal funds rate down to as low as 7% by next summer, and the discount rate--the rate the Fed charges member banks for loans--down to 6.5%.

“This one cut won’t do much, but it is the direction that is important,” said Solberg. “It represents a shift in policy toward lower rates.”