Interest Rates Cut to Spur Economy : Finance: Fed trim of quarter of point surprises many analysts, who thought budget impasse would block move. Experts see more reductions as stocks reverse nose dive.
The Federal Reserve, acting to counter growing financial anxiety over the federal budget impasse and to jog a slow-moving economy, lowered short-term interest rates by one-quarter of a percentage point Tuesday. The move immediately turned around falling stock prices on Wall Street and reduced consumer loan rates at some banks.
The Fed’s action surprised many analysts, who thought the central bank would hold off on lowering rates until political leaders solve their standoff on balancing the federal budget. The impasse was blamed for a 101-point drop in the Dow Jones industrial average on Monday, as investors feared the political struggle would discourage the Fed from moving soon.
The cut, which many analysts predicted will be followed by more reductions early next year, will lead to moderate declines in many consumer loans and may boost last-minute holiday retail sales. Retailers have been worried that tepid sales this fall will leave them with huge inventories of unsold goods.
Immediately after the 2:15 p.m. announcement, stocks and bonds rallied on Wall Street, with the Dow Jones industrial average--down about 20 points before the central bank’s action--climbing to end the day at 5109.89, which was 34.68 points above Monday’s closing.
Banc One Corp. of Columbus, Ohio, the country’s eighth-largest bank, reacted by announcing that it will cut its prime lending rate--a benchmark for business and consumer loans--to 8.5% from 8.75%. Other major banks were expected to follow suit.
The Fed move leaves the benchmark federal funds rate at 5.5%. It was the second drop in short-term rates this year, and followed an easing of the same magnitude in July.
“We don’t see this as a last step. We think there’s more to come early next year,” said Maria Fiorini Ramirez, an investment advisor in New York.
In Southern California, the rate cut is expected to help boost the residential real estate market, which has been showing signs of reviving after a five-year slump. Home sales have already benefited from rate cuts earlier this year and from the region’s improving economy, economists and real estate agents said. Falling interest rates would certainly help realize predictions of a rise in California home prices in 1996 after years of decline.
“It’s going to have a greater impact on our real estate local market than on the national level because we have more pent-up demand than the rest of the nation,” said Jack Kyser, chief economist for the Los Angeles County Economic Development Corp.
Evidence of a sluggish national economy with little inflationary pressure persuaded Fed policymakers to impose the modest rate cut, economists said. Federal Reserve Chairman Alan Greenspan announced the action after a meeting of the Fed’s Open Market Committee, which sets interest-rate policy.
Since July, “inflation has been somewhat more favorable than anticipated, and this result, along with an associated moderation in inflation expectations, warrants a modest easing in monetary conditions,” Greenspan said in his three-sentence statement.
The federal funds rate, which banks charge each other for overnight loans, affects credit costs for many consumers and small businesses, because it influences the prime lending rate.
Tuesday’s announcement came as much of the financial world remained riveted to the stormy budget debate in Washington.
Perceptions had spread that Republicans in Congress and the White House would fail to agree on eliminating the deficit, rocking financial markets.
In response to such anxieties, President Clinton maintained Tuesday that progress to reduce the deficit would continue.
“If the markets are worried about whether the deficit is going to keep coming down, they should forget about that,” Clinton told reporters. “The deficit’s going to keep coming down regardless.”
The link between struggles on Capitol Hill and gyrations in the financial world was further underscored Tuesday by a newspaper advertisement paid for by executives of more than 90 industrial and financial companies.
“We are convinced that the health of our economy rests on your ability to avoid political gridlock and give the American people what leaders of both parties say they favor and, indeed, have agreed to--a credible plan to balance the budget,” said the ad, which appeared in a number of major newspapers.
Executives signing the ad included the heads of IBM, AT&T;, Chrysler, General Motors, Ford, Exxon, Goldman Sachs and Salomon Bros.
The logic that connects recent swings on Wall Street and battles on Capitol Hill goes something like this: Moving toward a balanced federal budget--with a large dose of spending curbs--could exert a drag on economic growth, thereby prompting the Fed to respond with the stimulus of lower rates.
Perceptions that deficit reduction is in the works raise the likelihood of future rate cuts and cheer up the markets; perceptions that it is slipping away cause worried sell-offs.
“I think if the Fed had not eased today, the markets would have been very disappointed,” said Stephen E. Bell, managing director in Salomon’s Washington office.
Beyond the financial calculus, economic realities made a solid case for easing, which could continue for another half a percentage point next year, economists said.
Retail sales, job growth and industrial output have all been generally lackluster, suggesting an economy that is performing below the average, according to analysts.
In addition, a round of interest-rate cuts last week in Germany and elsewhere in Europe has exerted downward pressure on U.S. rates, which by some measures are above historical levels relative to inflation.
Consumer inflation is running at 2.7% this year, barely above the levels of 1993 and 1994, further giving the Fed room to maneuver without fear of igniting price hikes.
“The economy is not going to grow very rapidly,” said Joseph A. Wahed, chief economist at Wells Fargo Bank in San Francisco.
Given the signs of a slower economy without inflation, the budget impasse in Washington looms as the major obstacle to further rate declines, analysts said.
“In our view, the Fed action was overdue, given the sluggish state of the U.S. economy,” said economists at the Merrill Lynch investment firm, adding that “we expect further rounds of Fed easing.”
