Fed Cuts Prime Rate By Half Point

Wednesday, March 21st 2001, 12:00 am
By: News On 6

NEW YORK - The Federal Reserve cut interest rates by half a percentage point Tuesday and signaled more cuts may be needed to prevent further weakness in the U.S. economy.

The move, coming after two half-point cuts earlier this year, took the rate that banks charge each other for overnight loans to 5 percent from 5.50 percent.

The Fed's latest reduction in borrowing costs came with an unusual mention of the stock market, whose steady losses amid sagging corporate profits have caused the first bear market since 1987.

But Wall Street, where some wanted a larger rate cut, was unimpressed. U.S. stocks, higher before the move, fell sharply after the 2:15 p.m. ET announcement.

Policy makers in their statement blamed "declines in equity wealth" in part for "restraining investment spending" that has threatened to end a record U.S. economic expansion.

During the last three months of 2000, the growth rate in the U.S. gross domestic product fell to its lowest level in 5-1/2 years. Some economists predict this could lead to a recession, or two quarters of negative growth, this year.

Within moments after the Fed move, several of the nation's biggest banks cut their own interest rates, a development that could cheapen the cost of mortgages, car loans and credit card payments.

The Fed, in its statement, issued a pessimistic outlook, saying risks "are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

"This reads like they are more scared than they have been willing to admit," said Ian Shepherdson, chief U.S. economist at High Frequency Economics. "And that they are ready to cut rates further - maybe soon."

Mike Moran, chief economist at Daiwa Securities, said the Fed's "dour" tone is sure to mean more cuts in the federal funds rate down the road.

"Policy makers signaled that they plan to ease aggressively," said Moran, who says the fed funds rate could fall to 4 percent in the months ahead.

Some analysts wanted the Federal Open Market Committee, the central bank's policy arm, to make a more aggressive three-quarter-point cut. But others said evidence of economic resilience in the housing and labor markets gives Fed Chairman Alan Greenspan time to trim later.

The Fed also cut the discount rate, the rate of interest the central bank charges commercial banks to borrow money, to 4.50 percent from 5 percent. The fed funds rate now stands at its lowest level since August, 1999 – a result of rapid moves from a central bank that was raising rates this time last year.

Manufacturing has led the economy's weakness. But home sales have stayed strong while the unemployment rate held steady at 4.2 percent in February, nearly a 30-year low.

Still, the Fed mentioned the pressures on corporate profits, the decline in equity prices, and weakness in overseas economies. No reference was made to inflation, whose limited gains make it easier to keep cutting rates.

This year's three half-point rate cuts follow six hikes between the summer of 1999 and 2000 that some say went too far. Greenspan, appearing before Congress last month, defended the increases that ended last May.

But a lot has changed since then. The Fed's latest cut comes amid new concerns that the slowdown in Japan, the world's second largest economy, is gaining strength. On Monday, Japan's central bank decided to guide down interest rates to near zero. The Nasdaq composite index, which rose above 5,000 last year, now trades more than 63 percent below those levels. And Corporate America just wound up its worst quarter for profits since the summer of 1998.

The suffering economy has gained more and more attention in recent weeks. President Bush has pointed to the slowdown as a reason for his $1.6 trillion tax cut. Time magazine put the bear market story on its cover this week.

But rate cuts take time to affect the economy, meaning the predicted turnaround in consumer and business spending, corporate profits and the stock market could be months away.

And some call a cut between now and the Fed's next meeting on May 15 a possibility.

"My suspicion is that they are really leaving the door open, at least a crack, to an inter-meeting move," said Anthony Chan, chief economist at Bank One Investment Advisors.

Stocks are down sharply since the Fed first cut rate on Jan. 3 even though shares prices generally rise during periods of Fed easing. But Ned Riley told Jan Hopkins of CNNfn's Street Sweep that he expects the market to gain in the months ahead.