Fed Cuts Key Rate Half a Point to 4%
The Federal Reserve cut its key interest rate another half percentage point to 4% on Tuesday and, contrary to what had been expected, left the door open for still more cuts aimed at getting the stumbling U.S. economy moving again.
It was the fifth time in five months that the central bank shaved the so-called federal funds rate, a benchmark for interest rates in general, and continued one of the swiftest rate reductions in Fed history.
Fed Chairman Alan Greenspan and his colleagues on the policymaking Federal Open Market Committee seemed particularly worried Tuesday about corporate America, which posted its slimmest profits in a decade during the first three months of the year.
“The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook . . . continues to weigh on the economy,” they said in a statement.
But on other matters, the central bankers sounded almost upbeat. Consumers are still spending--even on such expensive items as houses--and a buildup of unsold goods that frightened businesses earlier this year had been largely worked off.
Some economists had predicted that signs of improvement would convince the Fed to couple its new rate reduction with word that it intended to put off further cuts for the time being.
But the central bank was having none of it.
“They are leaning a little more into the cuts than I would have thought. They want to make sure the corporate sector recovers,” said David A. Wyss, chief economist with Standard & Poor’s in New York.
“They don’t want anyone accusing them of standing on the sidelines” during an economic downturn, said Rajeev Dhawan, economic forecasting director with Georgia State University in Atlanta.
Lenders reacted quickly to the Fed action, with Bank of America Corp. and Bank One Corp., the nation’s third- and fifth-largest banks, saying they will cut their prime lending rate a half-point to 7%. Fed officials are counting on such cuts to boost the economy by spurring new spending and investment.
But investors were cool to the central bank’s decision. Stock prices rose slightly after the Fed’s announcement, only to slump back. Analysts said buyers saw evidence of continued economic weakness and insufficient enthusiasm for more rate cuts in the Fed’s statement.
The Dow Jones industrial average ended the day down slightly more than 4 points, and the Nasdaq composite index rose a fraction less than 4 points.
Bond investors, meanwhile, appeared to worry that the Fed would cut so deep as to risk inflation. The price of a 30-year U.S. Treasury bond, which is most affected by inflation fears, fell by $7.50 per $1,000 face amount, pushing its yield up 0.06 point to 5.91%--a seven-month high.
By contrast, the yield on two-year Treasury notes fell slightly to 4.25%. Analysts consider the widening gap between the two rates a sign that inflation could pick up as the economy recovers.
Fed officials, seeking to play down inflation worries, said that “with pressure on labor and product markets easing, inflation is expected to remain contained.” They insisted, as they have all year, that the greater risk facing the nation is “economic weakness.”
But the economy has recently sent some mixed signals, making the central bank’s job unusually difficult.
After the economy seemed to stall last fall, corporate America slashed production, pulled the plug on capital spending and began announcing layoffs. But consumers, who appeared to be pulling back early in the year, regained their footing and resumed their spending.
The result was that large swaths of the economy, including the housing and auto industries, remained stronger than anyone had expected. Growth, which even Greenspan suggested had stopped, picked up modestly in the early months of the year.
Retail sales began to recover, consumer confidence bounced back, and the stock and bond markets rallied.
But at the same time have come troubling warnings. The economy lost 223,000 jobs in April and factory output fell for a seventh straight month to its lowest level in a decade.
“Basically, it’s almost as if the Fed has had to deal with a recession that’s flipped on its head,” said Kathleen Camilli, chief economist with Tucker Anthony Sutro in New York.
The central bank reacted by dropping its traditional cautiousness in favor of a series of quick and comparatively steep rate cuts. Since Jan. 3, it has driven the fed funds rate from 6.5% to 4%, its lowest level in seven years.
Analysts said the Fed chairman had apparently become convinced that if the central bank overshot its goal of rekindling growth and touched off inflation, it could fix the problem by reversing course and raising rates.
“The Fed believes it has plenty of options” to control inflation if it revives, said Richard Berner, chief U.S. economist with Morgan Stanley in New York. “There’s no reason for putting the brakes on now.”
In addition to cutting the federal funds rate Tuesday, the Fed also lowered the largely symbolic discount rate by a half-point to 3.5%. The federal funds rate is the interest that banks charge each other for short-term loans.
The Fed itself charges banks the discount rate for short-term loans.
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