Quote:Fed Cuts Key Interest Rate by 3/4 of a Point
By EDMUND L. ANDREWS
Published: March 18, 2008
WASHINGTON — The Federal Reserve reduced its benchmark interest rate by three-quarters of a percentage point on Tuesday, to 2.25 percent, a cut that was less than investors had been hoping for even though it was one of the deepest in Fed history.
While leaving the door open for additional rate cuts, policy makers also expressed growing concern about inflation. “Uncertainty about the inflation outlook has increased,” the central bank said. “It will be necessary to continue to monitor inflation developments carefully.”
The statement highlighted the growing problem that the Fed faces, between fighting an economic downturn and heading off new inflationary pressures that have become apparent in everything from energy and food prices to the falling value of the dollar.
In a sign of the difficult choices the Fed faces, 2 of the 10 members of the policy-making Federal Open Market Committee dissented from the decision, favoring a smaller rate cut.
The two dissenters in Tuesday’s decision were Richard W. Fisher, president of the Dallas Fed, and Charles I. Plosser, president of the Philadelphia Fed, both of whom have been outspokenly hawkish about inflation issues in recent months.
The Fed’s announcement was the culmination of an extraordinary series of actions over the last two weeks to prop up financial markets and the economy with a flood of cheaper money.
The Federal Reserve has reduced its overnight lending rate, the federal funds rate, six times since September, and did so twice in January alone.
With the latest reduction, the federal funds rate is far below the rate of inflation, meaning that the “real,” or inflation-adjusted, rate is below zero. It is also well below the European Central Bank’s benchmark interest rate of 4 percent or the Bank of England’s rate of 5.25 percent.
Investors had already assumed that the central bank would reduce the cost of borrowing by at least another three-quarters of a percent on Tuesday, but mounting worries about a meltdown in financial markets and the Fed’s emergence as lender of last resort had elevated expectations even higher.
Indeed, expectations about another deep cut in interest rates were so high that the central bank was at risk of setting off a new wave of panicky selling if it had announced a reduction of less than three-quarters of a percentage point.
A lower federal funds usually leads to lower interest rates for mortgages, consumer loans and commercial borrowing.
But Fed officials had been startled and frustrated that their previous rate reductions were doing nothing to lower the long-term interest rates that are most relevant for expanding a business or buying homes or cars.
Part of the reason, analysts said, is that lower overnight interest rates have only limited relevance to the fundamental problem that is roiling the credit markets and the economy: the huge losses caused by the collapse of the housing bubble and the home loan environment that fed it.
Most analysts predict that housing prices, which have already fallen in most parts of the country, will drop much further before they hit bottom.
About eight million homeowners already owe more on their mortgage than their houses are currently worth, and foreclosure rates have soared over the last year.
The Fed’s problem is that its primary tools for stimulating growth — reductions in the cost of borrowing — do little to address the fears about bad loans. Many if not most private forecasters have concluded that the United States has probably entered a recession. The Labor Department has reported back-to-back declines in payroll employment in January and February.
And while the unemployment rate is still low at 4.8 percent, the number of private-sector jobs has declined for three months in a row — a pattern that has almost always been accompanied by a recession in recent decades.
With financial markets becoming dysfunctional, Fed officials have announced a series of steadily bigger lending programs for banks and cash-strapped Wall Street investment firms.
On Sunday, Fed officials agreed to lend up to $30 billion to JPMorgan Chase to engineer its takeover of Bear Stearns, a major Wall Street firm that was near collapse.
But Fed officials face increasingly contradictory pressures: inflation is rising even though growth has stalled.
The federal funds rate is once again edging close to zero, at which point the central bank would have to resort to entirely new strategies if it wants to keep opening its monetary spigots.
But a growing number of economists, including some Fed officials, contend that the housing bubble and bust stemmed at least in part from the central bank’s own decision to keep interest rates at rock-bottom lows from 2001 to the middle of 2004.
Meanwhile, consumer prices, even after excluding the volatile prices of food and energy, are climbing faster than the central bank’s unofficial target of less than 2 percent a year. On Tuesday, the Labor Department said the core measure of the producer price index, which excludes volatile energy and food products, jumped 0.5 percent in February, the biggest gain since November 2006.
The value of the dollar has plunged against most major currencies, a trend that pushes up the prices of imported goods and has contributed to the surging price of oil.
I was really hoping they would cut the rate by a full point. I hate to see the dollar get trashed any more than it already has, but the rate cut is really handy for those in the housing market (like me!).
-b0b
(...hopes mortgage rates drop by at least 50 basis points next week.)