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Fed, in Surprise Move, Cuts Interest Rates; Dow Up 330

TIMES STAFF WRITER

In a sign of heightened worries about the nation’s economy, the Federal Reserve Board unexpectedly lowered interest rates Thursday for the second time in less than three weeks.

The central bank’s decision to cut two short-term rates by a quarter of a percentage point each caught Wall Street by surprise and sparked an explosive rally that sent the Dow Jones industrial average soaring 330.58 points to close at 8,299.36.

The move came amid increasing evidence that overseas financial turmoil has injured American firms and begun to squeeze available credit in this country.

Analysts regarded Thursday’s action as part of a series of rate cuts that could continue into next year. The extraordinary timing--a month in advance of the Nov. 17 meeting of the Fed’s policymaking committee--underlined the urgency seen by the Fed. “What raises a concern in my mind is why did they have to do it now?” asked Chris Varvares, an analyst with Macroeconomic Advisers in St. Louis. “Why couldn’t they wait?”

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The central bank eased the federal funds rate, which banks charge one another for overnight loans, to 5% from 5.25%. Fed officials had lowered that same rate by a quarter-point Sept. 29.

The Fed also lowered the discount rate, which it charges commercial banks for emergency loans, to 4.75% from 5%, responding to requests from most of the regional bank presidents in the Federal Reserve System.

It was the first time the Fed acted between meetings of its rate-setting Federal Open Market Committee since April 18, 1994.

In a statement, the Fed in effect warned that lower rates were needed to combat an economic slowdown because worried lenders have become less willing to provide credit and a plunging stock market is taking a toll on American consumers and business.

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“Growing caution by lenders, and unsettled conditions in financial markets more generally, are likely to be restraining aggregate demand in the future,” the central bank said.

“Against this backdrop, further easing of the stance of monetary policy was judged to be warranted to sustain economic growth in the context of contained inflation.”

A course of lower interest rates over the next several months would help the economy in a variety of ways, economists said. In theory, a sufficient drop in rates--perhaps by another percentage point--would offset a developing credit crunch affecting business and some consumers. It also would fuel a multitude of purchases and investments, providing a boost to the domestic economy and hope to recession-battered nations overseas, who depend on American consumers to purchase their products.

Banks routinely lower their prime lending rates after such a Fed move, thereby reducing costs on a range of credit card and other consumer loans.

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“It’s exactly the right thing to do,” said Gordon Richards, chief economist at the National Assn. of Manufacturers.

Lower rates also weaken the dollar, making U.S. exports more competitive and easing pressure on weakened overseas currencies. The greenback fell to 116.75 Japanese yen in New York, from 118.98 on Wednesday, after the Fed’s move.

In just the last few days, there have been clear signs that overseas economic turmoil is hitting home, with U.S. firms suffering from losses in turbulent financial markets. On Wednesday, BankAmerica Corp. reported a 78% plunge in earnings for the third quarter; the day before that, investment firm Merrill Lynch & Co. said it would slash 3,400 jobs, or about 5% of its work force.

Fed Chairman Alan Greenspan has cited signs of a credit crunch as a troubling development for the economy. Despite the Fed’s Sept. 29 rate cut, for example, some interest rates, such as for mortgages, have risen in recent days.

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Some forecasters viewed Thursday’s action as just one step in a much broader decline in interest rates over the next year, as the Fed mounts an effort to fortify the economy against fallout from overseas.

“We feel that further easings are justified--at least [half a point] by the end of the year,” said Gerald D. Cohen, a senior economist with Merrill Lynch in New York. “And even with that, the economy is going to slow significantly in 1999.”

Said James F. O’Sullivan, an economist with the J.P. Morgan & Co. investment firm: “We would say this is the second of many, many more easings to come. . . . The question obviously being raised is, does the Fed taking this action solve the problem? I guess our feeling is that there’s still a slowing to come.”

Yet others responded that the Fed’s new course raises hopes that the U.S. expansion could endure next year and beyond. Lower interest rates are the major available policy tool for confronting signs of a slowdown.

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“At this point, there’s still a significant potential for the Fed to stave off a U.S. recession if they continue to act aggressively,” said Philip Braverman, chief economist with the DKB Securities investment firm in New York.

There was no immediate sign that the Fed move was part of a rate cut orchestrated with central banks in Europe and Japan, although analysts said other countries would soon conclude that similar rate reductions would be in their best interest. American officials have said such a coordinated effort might provide a welcome kick to the ailing global economy.

Britain, Canada, Spain, Portugal, Ireland, Greece, Denmark and Japan have already cut rates in recent weeks. But the key nation of Germany has remained aloof.

“I think that central banks around the world will be cutting rates, but independently and in an isolated way,” said Allen Sinai, chief economist at Primark Decision Economics in Boston.

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* THE EFFECTS

Rate cut is expected to lead to cheaper mortgages and credit card charges. C1

* ANALYSIS

The Fed has “messages” for different constituencies, Tom Petruno writes. C1

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