The Federal Reserve Wednesday cut a key interest rate by a quarter-percentage point to its lowest level in 45 years in the central bank’s latest bid to ensure the sluggish economy at last kicks into higher gear. The rate cut disappointed some in financial markets, who had hoped for a more aggressive half-point reduction.
It was the Fed's 13th rate cut since early 2001 and brought the federal funds rate, which banks charge each other for overnight loans, to 1 percent, the lowest level since 1958.
For consumers, the rate cut likely will have little impact, as mortgage rates already have fallen sharply in recent weeks in anticipation of the move. Rates on certain loans tied to the prime rate, like home equity loans, could come down a bit, but that benefit will be offset — particularly for senior citizens and others on fixed incomes — by lower rates on bank deposits and interest-bearing securities.
In a statement explaining the decision, the Fed said the economy “has yet to exhibit sustainable growth” despite recent signs of improvement. The policy-making Federal Open Market Committee voted 11-1 in favor of the rate cut, with San Francisco Fed President Robert T. Parry dissenting because he favored the larger cut of a half-point, or 50 basis points, the Fed said.
The Fed also cut the discount rate, for loans made through the Federal Reserve system, a quarter-point to 2 percent.
Traders and Wall Street economists were unanimous in expecting a rate cut, although they had been sharply divided on its magnitude. Stock prices fell more than 1 percent after the smaller quarter-point cut was announced, and long-term interest rates rose on the bond market.
“We were a bit disappointed,” said Ethan Harris, chief U.S. economist for Lehman Bros. “We were hoping for a 50 basis-point cut. We thought that that would be a strong statement of jump-starting the economy going forward.”
He said the smaller rate-cut was a “mistake” because it will undercut a sustained rally that has developed on both stock and bond markets.
“On the other hand they have made it clear they are not raising interest rates anytime soon,” Harris said. “That is the most positive message out of this.”
In fact analysts said the Fed left the door open to cut short-term rates yet again or take other action if needed to battle deflation, which the central bank has identified as the biggest threat facing the economy. A widespread outbreak of falling prices, while considered a remote possibility, could be economically devastating, leading to a long cycle of falling wages and shrinking output that would be hard to reverse.
“I don’t think they’re done,” said David Rosenberg, chief economist at Merrill Lynch. He said the Fed could cut rates again as early as its next meeting of policy-makers in August unless economic data show substantial improvement.
“Sifting through the press statement it seems that net-on-net, they still have an easing bias,” he said.
Since the economy slipped into recession in March 2001, recovery has been elusive, frustrating investors, job-seekers and government policy-makers. Nearly 2.4 million jobs have disappeared, sending the jobless rate from 4.2 percent to its current 6.1 percent. The gross domestic product has inched ahead at a rate of less than 2 percent, compared with the 3.5 percent rate that is considered the economy’s long-term potential.
Many analysts believe the economy is poised for faster growth in the second half of this year, boosted by the historically low interest rates, a weakened dollar and the $350 billion tax cut package that was passed by Congress and signed into law this year.
HOUSING MARKET BOOSTED
By cutting short-term interest rates over the past two and a half years, the Fed has slashed the cost of borrowing on a range of business and consumer loans. The words and actions of Fed Chairman Alan Greenspan and his colleagues also have helped bring down mortgage rates to their lowest levels in more than 30 years, triggering a new wave of refinancing and buoying the housing market, one of the few consistent bright spots in the economic gloom.
Mark Zandi, chief economist for Economy.com said the central bank now has become more interested in influencing long-term rates as a way to stimulate the economy. He said the Fed could keep up the pressure on bond rates through a “more explicit” statement on how it plans to conduct monetary policy or by pursuing unconventional methods like buying long-term securities on the open market.
On Wednesday, as the rate-setting Federal Open Market Committee was preparing to conclude its two-day meeting, the Commerce Department reported that new-home sales rose 12.5 percent in May to a record annual rate of 1.16 million units. Sales of existing homes also rose slightly last month, a trade group reported.
But orders for durable goods fell 0.3 percent, a far worse performance than expected, underscoring the weakness of the manufacturing sector and the generally mixed economic signals overall.
The complete text of the statement approved by FOMC follows.
FULL FED STATEMENT
The Federal Open Market Committee decided today to lower its target for the federal funds rate by 25 basis points to 1 percent. In a related action, the Board of Governors approved a 25 basis point reduction in the discount rate to 2 percent.
The Committee continues to believe that an accommodative stance of monetary policy, coupled with still robust underlying growth in productivity, is providing important ongoing support to economic activity. Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing. The economy, nonetheless, has yet to exhibit sustainable growth. With inflationary expectations subdued, the Committee judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time.
The Committee perceives that the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. In contrast, the probability, though minor, of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level. On balance, the Committee believes that the latter concern is likely to predominate for the foreseeable future.
Voting for the FOMC monetary policy action were Alan Greenspan, Chairman; Ben S. Bernanke; Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; and Jamie B. Stewart, Jr.
Voting against the action was Robert T. Parry. President Parry preferred a 50 basis point reduction in the target for the federal funds rate.
In taking the discount rate action, the Federal Reserve Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, St. Louis, Kansas City, and San Francisco.