Fed cuts key rate by a quarter-point

April 30, 2008 6:20:20 PM PDT
The ailing economy may have gotten its last dose of bracing tonic for a while. The Federal Reserve is hoping it won't have to refill the prescription. The Fed cut interest rates to the lowest point in nearly four years Wednesday as the nation teetered on the edge of recession. In fact, the Fed's trim was smaller than those of recent months amid indications the central bank might pause to see whether months of powerful rate cuts and billions of dollars in stimulus checks will be enough to lift the country out of its slump.

Chairman Ben Bernanke led a divided Fed, in an 8-2 vote, in slicing its key rate by one-quarter percentage point to 2 percent.

In turn, the prime lending rate for millions of consumers and businesses fell by a corresponding amount, to 5 percent. The prime rate applies to certain credit cards, home equity lines of credit and other loans. Both rates are the lowest since late 2004.

The Federal Reserve, which has been dropping rates since September, turned much more forceful early this year when housing, credit and financial problems worsened. Rate reductions in January and March alone marked the most aggressive intervention in a quarter-century in an effort to re-energize consumers and businesses.

Enthusiastic Wall Street investors initially drove the Dow Jones industrial average up more than 178 points - lifting it above 13,000 for the first time since early January. Then traders' caution returned, and the index ended the day down 11.81 points.

Although the Fed didn't take the prospect of another reduction off the table, a growing number of economists believe the central bank is winding down its rate-cutting campaign. Barring another hit to economic growth, they believe rates probably will stay where they are - perhaps through the rest of this year - in part because the Fed is concerned that further cuts could join with galloping energy and food prices and spread inflation dangerously higher.

By all accounts, the country's economic health is fragile.

The economy crawled ahead at a pace of just 0.6 percent from January through March as housing and credit problems forced people and businesses to hunker down, the Commerce Department reported hours before the Fed's action. Growth had been just as feeble in the prior quarter.

Job losses for the first three months of the year neared the staggering quarter-million mark, and a government report on Friday is expected to show that employers shed jobs again in April. The unemployment rate, now at 5.1 percent, also could creep higher in April and hit 6 percent early next year, analysts say.

"Recent information indicates that economic activity remains weak," the Fed said. "Household and business spending has been subdued, and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters."

Two members - Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and Richard Fisher, president of the Federal Reserve Bank of Dallas - opposed cutting rates Wednesday, a crack in the usually unified front the Fed often shows the public.

Both men have a reputation for being especially vigilant about fighting inflation. At the Fed's previous meeting in March, they opposed cutting rates by a whopping three-quarters point and preferred a smaller reduction.

"The Fed didn't completely shut the door on rate cuts but they closed it part way," said Mark Zandi, chief economist at Moody's Economy.com. "I think the overall message was they've done a lot already to help the economy and think this will be enough. But they stand ready to do more if that is needed."

Bernanke's juggling act is getting harder. Fed policymakers are trying to bolster economic growth, and at the same time they are mindful that they can't let inflation get out of hand. The very rate reductions the Fed depends on to energize the economy can also sow the seeds of inflation down the road.

At the same time, many economists believe the economy already is declining.

Under one rough rule, if the economy contracts for six straight months it is considered to be in recession. However, that didn't happen in the last recession - in 2001. A panel of experts at the National Bureau of Economic Research that determines when U.S. recessions begin and end uses a broader definition, taking into account income, employment and other barometers. The bureau's finding is usually made well after the fact.

The Fed's previous rate reductions, which take months to work their way through the economy, should help lift growth in the second half of this year. The government's $168 billion economic-stimulus package - including tax rebates that started flowing to bank accounts on Monday - also should help energize activity, the Bush administration, Bernanke and private economists have said.

The biggest weight on the economy is the housing crisis, which has pushed foreclosures to record highs and caused financial institutions to rack up billions of dollars in losses.

For mortgage rates, the Fed's latest cut probably won't have much, if any, impact.

Rates on longer-term 30-year and 15-year mortgages, which are linked to the 10-year Treasury notes, actually could see rates rise in the weeks ahead in part because of concerns about higher inflation. Rates on shorter-term mortgages probably won't drop either because investors already had factored in the latest Federal Reserve action.

Still, people with adjustable-rate home loans have been helped by the Fed's series of rate reductions; they would have been socked with much higher rates when their mortgages reset if not for the Federal Reserve cuts, analysts said. "Going forward, if the Fed holds rate steady, resets in the pipeline would benefit in a similar fashion as still-low interest rates would mean very manageable mortgage-rate resets," said Greg McBride, senior financial analyst at Bankrate.com.