Fed Acts Again to Push Down Interest Rates : Economy: As more signs point to a deepening recession, it allows the rate that banks charge each other for overnight loans to fall to 6.75%.
Amid growing fears that the recession and banking crisis may be worsening, the Federal Reserve Board moved Tuesday to drive down interest rates, the sixth reduction it has engineered since Iraq’s invasion of Kuwait last August.
Although the Fed made no announcement of its move, it apparently allowed the benchmark federal funds rate to fall to about 6.75%, down a quarter of a percentage point from its previous level of 7%, market analysts said.
The Fed has engineered a cut in the federal funds rate--what banks charge each other for overnight loans--five times since August, when it stood at 8%. Although the board cannot force banks to go along, it manipulates the rate through its intervention in the credit markets by buying or selling Treasury securities.
In addition to the funds rate reductions, the central bank cut the discount rate--what the Fed charges member banks for loans--by half a percentage point shortly before Christmas.
Besides the rate cuts, the Fed moved late last year to ease its grip on monetary policy by reducing its requirements on the amount of money that banks must hold in reserve to back up their deposits. The policy change freed up more funds for consumer and commercial lending.
Tuesday’s decline in the federal funds rate led to a rally in prices of short-term Treasury bills, but prices on long-term 30-year Treasury bonds fell because of worries about higher inflation and prospects of a Persian Gulf war. Bond prices usually rise when interest rates fall.
The latest move followed a flurry of actions by the Fed in December to ease its grip on the economy. Coming so quickly after the discount rate reduction, the funds cut signals Fed Chairman Alan Greenspan’s increasing concern about the health of the banking industry and the economy in general, analysts said.
“The general impression that most people get now is that we are in for a further weakening, and that the economy seems listless,” observed Robert Hormats, vice chairman of Goldman Sachs International in New York. “I think the Fed sees things in the same way.”
Analysts noted that the key economic indicators monitored by the Fed as it sets interest rate targets are looking uniformly grim.
In fact, one of the Fed’s most important indicators--the rate of growth of the money supply--has offered particularly negative readings lately. Money supply growth fell to an annual rate of zero during the fourth quarter, far below the central bank’s targets.
A stagnant money supply indicates that the economy is contracting, prompting the Fed to act quickly, analysts said. As a result, the central bank did not wait for the government reports on December’s inflation rate--due later this month--before deciding to ease further. Greenspan clearly believes that inflation is no longer as great a threat to the economy as the possibility of a severe slump.
In fact, the lack of money growth reflects just how difficult it has become for banks to expand their lending activity, even with the Fed’s easier policies. Before banks can increase lending, they must shore up their balance sheets, which were severely weakened by the real estate and junk bond borrowing binges of the 1980s.
“Banks are really having trouble cleaning up their books,” noted Alan Levenson, a financial economist at the WEFA Group, an economic forecasting firm in Bala-Cynwyd, Pa.
