Fed Cuts Rates by Three-Quarters Percentage Point
Washington - The Federal Reserve on Tuesday slashed a key interest rate by three-fourths of a percentage point, moving aggressively to contain a credit crisis threatening to push the country into a severe recession.
The latest action brought the federal funds rate - the interest that banks charge each other - down to 2.25 percent, the lowest point since late 2004. It marked the second back-to-back cuts of three-fourths of a percentage point.
Fed Chairman Ben Bernanke and his colleagues have now cut the funds rate six times since last September, with the reductions becoming more aggressive since January as the central bank has faced growing turmoil in global financial markets.
However, there has been opposition inside the Fed to the aggressive moves. The latest rate cut came on an 8-2 vote with two members of the Federal Open Market Committee dissenting. Both Richard Fisher, president of the Dallas regional Fed bank, and Charles Plosser, president of the Philadelphia regional Fed bank, voted against the rate cut, arguing they would have preferred less aggressive action.
In explaining its actions, the Fed said that it was having to navigate a difficult policy environment that included sluggish economic activity and rising inflation pressures.
The Fed statement said that "the outlook for economic activity has weakened further" but that "inflation has been elevated" with some signs that expectations of future inflation pressures are rising, a dangerous sign for the Fed.
But the Fed signaled that it stood ready to cut rates further if necessary, saying that "downside risks to growth remain." Bernanke and other Fed officials have said in recent comments that they view the threat of economic weakness as a bigger risk at the moment than inflation given the risks to financial markets.
"Financial markets remain under considerable stress and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters," the Fed said in its statement.
In Jacksonville, Fla., Tuesday, President Bush said the government will take further action - if necessary - to help the sagging economy.
The rate cut Tuesday caps an unprecedented period of Fed actions aimed at trying to stabilize financial markets and ward off a recession or at least keep it from being too severe.
While the cut was larger than the Fed's normal quarter-point moves, investors were initially disappointed that the central bank did not cut rates by a full percentage point.
The Dow Jones industrial average fell 100 points within two minutes of the Fed's mid-afternoon announcement but it then resumed climbing and was up nearly 200 points within the first half-hour after the announcement. It had been up 286 points just before the announcement as stocks had posted a strong rally after Lehman Brothers and Goldman Sachs reported better-than-expected results for the first quarter. That came as welcome news following the collapse over the weekend of Bear Stearns, which was forced into a fire-sale to JP Morgan Chase & Co.
The reduction in the funds rate was designed to lower borrowing costs and boost spending by consumers and businesses and thus increase economic activity. Economic growth slowed to a near standstill in the final three months of this year as the economy was hit by a series of blows including the credit crunch, a prolonged housing slump, rising unemployment and surging energy prices.
The funds rate cut quickly triggered announcements from commercial banks that they were cutting their prime lending rate to 5.25 percent from 6 percent, where it was before the Fed meeting. This rate is the benchmark for millions of business and consumer loans.
The spectacular fall of Bear Stearns, which had been the nation's fifth largest investment bank, has raised concerns about what other banks might fail as a result of multibillion-dollar losses that began last year with rising defaults on subprime mortgages, loans made to borrowers with weak credit histories.
The purchase of Bear Stearns by JPMorgan Chase & Co. was helped by a pledge from the Fed that it would supply a $30 billion line of credit to back up Bear Stearns' assets.
That offer was the latest in a number of unconventional moves the central bank has made, including employing Depression-era procedures to pump cash into the financial system.
In addition to providing support for the Bear Stearns sale, the Fed also announced Sunday one of the broadest expansions of its lending authority since the 1930s, saying it would allow securities dealers for at least the next six months to borrow directly from the Fed. That privilege had been confined to commercial banks.
In other moves, the Fed last week announced that it would lend up to $200 billion of Treasury securities that it owns to investment banks starting March 27 for a period of up to 28 days in return for a like amount of the investment banks' shunned mortgage-backed securities. The Fed also announced recently that it was boosting the size of special loans it has been making since December to commercial banks.