Fed Moves to Reduce Interest Rate
The Federal Reserve Board, in an apparent response to new signs of economic weakness, moved Thursday to reduce interest rates for the first time in nearly four months, surprising analysts and cheering stock traders rattled by two days of plunging prices.
The Federal Reserve accomplished the rate cut by injecting money into the banking system, causing the benchmark federal funds rate to fall to 3.75% from 4%. The federal funds rate is the amount of interest charged on loans that commercial banks make to one another.
President Bush, whose Administration has pressured the Fed to reduce rates further, hailed the move. “I hope that it will guarantee that this fledgling recovery that we’re seeing will now be a little more robust,” he told the American Society of Newspaper Editors.
Economists offered several explanations for the Fed’s action: recent evidence that the economy’s rebound may be faltering, concern that the nation’s money supply is not growing fast enough to fuel the recovery and increasing uneasiness about falling stock prices in Japan and the United States.
“The Fed cannot afford to take a chance on another dip occurring,” said Allen Sinai, chief economist of Boston Co. Economic Advisors Inc. in New York. “We have had too many false starts moving into recovery. It would be a devastating blow to confidence.”
While the move took many economists by surprise, it was not as dramatic as the Fed’s last rate cut. In December, it slashed the discount rate that it charges commercial banks by a full percentage point. The discount rate now stands at 3.5%, the lowest level in almost three decades.
Thursday’s relatively modest quarter-point reduction probably will not have a significant effect on the interest rates that banks charge consumers, analysts said. Even so, it was interpreted as a clear signal of the Fed’s willingness to take further action to keep the recovery on track.
The Fed makes no public announcement when it adjusts the federal funds rate, but it makes its intentions clear by adding to or reducing reserves in the banking system. The financial markets quickly picked up on the move: The Dow Jones industrial average of blue-chip stocks, which plunged a total of 94 points Tuesday and Wednesday, rose 43.61 points Thursday to close at 3,224.96.
The Fed’s action came shortly after the Labor Department reported that wholesale prices rose a scant 0.2% in March--the same as in February. The modest increase suggested that the central bank had room to reduce interest rates without rekindling inflationary pressures.
Later in the day, the Fed reported that the nation’s money supply fell $7.1 billion last week, continuing a sharp slide that began in early March. Sinai said that information, which would have been available to the Fed when its policy-making panel met last week, probably had the biggest influence on the decision to ease credit.
Sinai said that fluctuations in the money supply have proved to be “a very good indicator” of economic growth. “The error in the past was not looking at the monetary growth, and I don’t think the Fed wants to make that mistake again,” he said.
But analysts said that other factors probably influenced the Fed’s decision, including a growing body of anecdotal evidence suggesting diminished economic vigor in recent weeks.
While few official March figures have been released so far, “certainly, the March economy was nowhere near as strong as the February economy,” said Donald Ratajczak, who heads Georgia State University’s economic forecasting project.
The Labor Department reported Thursday that unemployment benefit claims filed by newly jobless workers dropped by 24,000 in the last week of March to 432,000. However, government officials stopped short of describing the dip as a significant turnaround in persistently high unemployment.
“I continue to be concerned with evidence of layoffs in the work force, even as the economy strengthens,” Labor Secretary Lynn Martin said.
Meanwhile, the Commerce Department reported that businesses plan to boost their investment in new plants and equipment by 4.6% this year, which is somewhat lower than had been anticipated and indicates continuing skittishness about the prospects for recovery.
And the nation’s largest retailers on Thursday reported that their sales in March were weaker than hoped, falling by as much as 12% for some firms. Analysts said that the disappointing results may be blamed in part on a late Easter and colder-than-usual temperatures, both of which would delay the spring shopping season.
Some analysts said that the Fed’s decision to lower interest rates also may reflect concern about the continuing decline in the Japanese stock market, which has fallen by more than 10% this week alone.
By cutting rates in this country, the Fed may reduce the value of the dollar, said David Hale, chief economist for Kemper Financial Services in Chicago. That, he added, would take pressure off the yen and allow the Japanese central bank to reduce that country’s rates as well.
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