Fed Cuts Rates But Hints Against Further Easing

The Federal Reserve, moving to head off the threat of a recession, cut two key interest rates by a quarter-point but signaled that it may be done easing rates for now.

J. Scott Applewhite / AP

The central bank lowered the federal funds rate to 4.5% and the discount rate to 5% in an effort to stimulate economic activity and keep the country from dipping into a recession. The move will make it cheaper for consumers and businesses to borrow money.

The Fed's action came on the same day the government announced that the overall economy grew at a stronger-than-expected 3.9% rate in the third quarter. And Fed policymakers signaled that Wednesday's cut may be all that is needed to deal with the weakening economy.

Still,  economists are worried that GDP growth will be less than half that amount in the current quarter as the country struggles with a deepening housing slump. And some Fed watchers said the central bank will need to cut rates further.

Need to Do More

"I'm satisfied for now," Bill Gross, manager of Pimco, the world's biggest bond fund, said on CNBC. "But ultimately, it's housing that dominates the economy, and ultimately the Fed has to move even lower, perhaps lower than 4 percent, in order to salvage the economy."

"Ultimately, over the next six to 12 months, what the Fed has to do, and what the Fed has done in prior cycles, is to move down to a 1 percent real (as opposed to nominal) interest
rate in order to restimulate the economy," Gross added.  "Three to 3.5 percent fed funds target is where they must go."

The Fed's vote was not unanimous. Kansas City Federal Reserve Bank President Thomas Hoenig dissented, preferring to hold borrowing costs steady. The cut in the fed funds rate, which is what banks charge each other for overnight loans and influences a host of consumer rates, was expected. The reduction in the discount rate, which is what the Fed charges banks for short-term loans, was a bit of a surprise.

Prices for U.S. interest rate futures contracts showed dealers were scaling back bets on further rate cuts on the back of the Fed's announcement, implying a 50 percent chance the Fed will lower rates again in December down from 64 percent overnight.

Credit markets, which were roiled in August as concerns mounted over rising delinquencies in the U.S. mortgage market, have regained some stability since the Fed lowered rates by a
half-percentage point on Sept. 18.

Housing, Credit Woes Linger

Fed officials have said they expect the housing slump and the after-effects of tighter credit to weigh on the economy into next year.

A string of gloomy economic reports in recent weeks, including slipping consumer confidence and tumbling home sales, had raised fears the economy might be weaker in coming quarters
than the Fed had anticipated.

However, as policy-makers convened Wednesday, a government report showed that growth in the third quarter was considerably stronger than most economists expected.

Despite signs consumer confidence was weakening, consumer spending rose at a 3 percent rate in the third quarter, up from a modest 1.4 percent gain in the prior three months. About
two-thirds of U.S. economic activity is fueled by consumers.

Also, a separate report showed private sector employers added more jobs than expected in October, implying more underlying strength to the economy than previously thought.

In general, the employment situation looks much more robust than when the Fed last met. A government report earlier this month showed the economy added a solid 110,000 jobs in
September, while August hiring was revised dramatically upward to a gain of 89,000 from an originally reported loss of 4,000.

© 2009 CNBC.com