Fed Cuts Rates by Half a Point

Wednesday, January 31st 2001, 12:00 am
By: News On 6

WASHINGTON (AP) — The Federal Reserve, seeking to prevent the faltering economy from slipping into a recession, cut a key interest rate by another half percentage point Wednesday.

``Consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins,'' the Fed said in a statement.

The decision came after a two-day, closed-door meeting of the Fed's chief policy-making group, the Federal Open Market Committee. The panel includes Fed Chairman Alan Greenspan, Fed governors and five of the 12 presidents of Federal Reserve banks.

The Fed said it was cutting its target for the federal funds rate — the interest banks charge each other on overnight loans — to 5.5 percent from 6 percent.

On Wall Street, the Fed's aggressive and widely anticipated rate cut Wednesday failed to bring much cheer to investors. The Dow Jones industrial average closed up 6.16 points at 10,887.36, according to preliminary calculations. The Dow lost the approximately 50-point gain it had before the Fed's decision. The Nasdaq fell 65.46 points to 2,772.89 after being up nearly 20 points. With Wall Street worrying about a recession, investors sold off stocks.

The Fed, in a rare move between regularly scheduled meetings, slashed interest rates by a half-point on Jan. 3, the biggest reduction in more than eight years.

Against the backdrop of the weakening economy and the fact that inflation, for the most part, remains tame, the Fed said that ``these circumstances have called for a rapid and forceful response of monetary policy.''

The Fed's half-point decrease in the funds rate Wednesday was quickly followed by announcements from Bank One and Bank of America that they were reducing their prime lending rate by a similar half point, from 9 percent to 8.5 percent, effective Thursday. Other commercial banks were expected to follow.

The prime rate is the key benchmark for millions of loans, from home equity and unpaid credit card balances to short-term loans for small businesses.

This marks the first time since Greenspan became Fed chairman in 1987 that the rate has been cut by a full percentage point in a single month.

Analysts said they expect additional rate cuts in the coming months.

``There is no question that the Fed chairman is pulling out all the stops to avoid a major blot on his otherwise shining record as Fed chairman,'' said David Jones, economist with Aubrey G. Lanston & Co.

Meanwhile, the new Bush administration through Treasury Secretary Paul O'Neill took a page from the Clinton administration's hands-off approach to the Fed's interest-rate decisions. O'Neill issued the usual statement, saying, ``The administration respects the independence of the Federal Reserve in making decisions about our nation's monetary policy.'' He did not comment on the substance of the Fed's decision.

The central bank also reduced its mostly symbolic discount rate, the interest that the Fed charges to make direct loans to banks, by a half point to 5 percent.

In the part of the Fed's statement that reflects possible future action, the central bank maintained its stance that its chief concern is the threat of the economy stalling and falling into a recession.

``The risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future,'' the Fed said.

The Fed's action comes as the economy has slowed dramatically since the second quarter of last year, when it grew by a sizzling 5.6 percent rate.

The extent of the slowdown was underscored with a government report Wednesday that the economy grew at an annual rate of just 1.4 percent in the fourth quarter, the weakest showing in more than five years.

Greenspan told Congress last week that economic growth is probably ``very close to zero'' in the current quarter. His comments bolstered economists' views that the Fed's rate cut on Jan. 3 would be followed with several more.

The Commerce Department said Wednesday that the slowdown in the gross domestic product was caused by weakness in consumer spending and a 1.5 percent rate of decrease in business investment, the biggest decline since 1991, when the economy was pulling out of its last recession.

Even before the GDP came out, the slowdown had been documented in a spate of troubling economic reports. Manufacturers are struggling, consumers are considerably less confident in the economy and companies are laying off thousands of workers in response to slackened demand.

And, driven down by growing fears of a recession, consumer confidence fell sharply in January, plunging to its lowest level in four years, an industry group reported Tuesday.

The Consumer Confidence Index dropped more than 14 points to 114.4, the lowest level since December 1996, when it was 114.2, the Conference Board said in New York.

Testifying before the Senate Budget Committee last week, Greenspan didn't rule out a recession, saying that would depend on whether the economy's ``marked decline breaches consumer confidence.''

Greenspan gave a bleak assessment of current economic conditions, saying, ``As far as we can judge, we have had a very dramatic slowing down and, indeed, we are probably very close to zero (growth) at this particular moment.''

The big question is whether Fed rate cuts will be enough to avert a recession, analysts said.

By lowering borrowing costs, the Fed aims to spur business investment and consumer spending, which would in turn boost economic growth.

Economists said the Fed has a lot of flexibility in cutting rates because inflation remains tame, except for a burst of higher energy prices.


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Federal Reserve: http://www.federalreserve.gov