Fed Cuts Rates Half Point To Lowest Level in 4 Years

The Federal Reserve slashed a key interest rate by half a percentage point as it seeks to revive an economy hit by a long list of maladies stemming from the most severe financial crisis in decades.

AP

The central bank on Wednesday reduced its target for the federal funds rate, the interest banks charge on overnight loans, to 1 percent, a low last seen in 2003-2004.

• Read Text of Fed's Statement
• Cut Has Limited Impact on Stocks
• Gross: Rates to Remain Steady

The funds rate has not been lower since 1958, when Dwight Eisenhower was president.

The cut marked the second half-point reduction in the funds rate this month. The Fed slashed the rate by that amount in a coordinated move with foreign central banks on Oct. 8.

In a brief statement explaining Wednesday's action, the Fed said the "intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and business to obtain credit."

The central bank said it had room to lower rates because the spreading economic weakness was lowering the risks that inflation would get out of control. Indeed, the weakness has caused dramatic declines in the price of oil and other commodities.

While many economists believe the country has already fallen into a recession, they think the aggressive efforts by the Fed to cut rates and take other actions to unfreeze credit markets will keep the country from plunging into a prolonged and deep downturn.

The Fed's action was expected to be quickly followed by a reduction by commercial banks in their prime lending rate, the benchmark for millions of consumer and business loans, by a similar half-point. 

But even if the Fed did fulfill the desires of investors, it is not likely to end the turbulence on Wall Street.

Big money reacts to Fed decision. Watch video at left.

Analysts are cautioning to be prepared for more stomach-churning days ahead as investors struggle to deal with a severe credit crisis and what could be the worst recession in at least two decades.

The Fed is hoping that the sharply lower rates will help boost economic growth going forward.

The government will release its first look at economic activity in the July-September quarter on Thursday and that is expected to show that the gross domestic product shrank at a rate of 0.5 percent in the third quarter.

Many analysts believe the GDP—the measure of the value of all the goods and services produced in the country—is falling further in the current quarter and will also fall in the first three months of next year.

That pattern would meet the classic definition of a recession as at least two consecutive quarters of declining GDP.

Many economists think that when the National Bureau of Economic Research, the official arbiter of when recessions begin and end in this country, makes its decision, it will date this downturn to the beginning of 2008, when the labor market started shedding jobs.

The country has lost jobs every month this year and the unemployment rate now stands at 6.1 percent.

Economists forecast that it could hit 8 percent by the spring of next year due to the severity of the shutdown of bank lending, a credit crisis triggered by billions of dollars of losses in mortgage lending as defaults soared to record levels.

That has jolted banks, resulted in government takeovers of the nation's two biggest mortgage companies and the biggest shakeup on Wall Street since the Great Depression.

Banks have become fearful about making new loans, a development that has had ripple effects on American businesses trying to get loans for normal operations, and on American consumers, who are having trouble getting car loans and home loans.

"The credit squeeze has moved from Wall Street to Main Street and it is seriously affecting the real economy and now it has gone global," said Sung Won Sohn, an economist at the Smith School of Business at California State University, Channel Islands.

Many analysts believe a rate cut in the United States will be followed by cuts in other major economies as central banks around the world try to inject confidence into a badly shaken financial system.

Analysts are split, however, on whether a Fed rate move this week will be followed by another rate cut at the central bank's last meeting of the year on Dec. 16.

Some analysts think the Fed could drive the funds rate as low as 0.5 percent and might even go to zero, which the Bank of Japan did in an effort to combat a decade-long bout of malaise in the 1990s caused by a real estate bust in that country.

Other analysts believe the Fed will be content to leave the funds rate at 1 percent, partly because pushing it any lower would remove any cushion to cut the rate further should the economy fail to respond and the downturn worsen.

These analysts believe the Fed will depend on its other efforts to battle the credit crisis, which involve supplying massive resources to the banking system.

David Jones, chief economist at DMJ Advisors, said that Fed officials will probably decide that all the global efforts to fight the credit squeeze, including a $700 billion rescue fund in this country, should be given time to work.

But Jones, who thinks the economy will remain in a recession until the middle of next year, said he believes that the Fed will signal that it is prepared to leave the funds rate at 1 percent for some time to come.

When the Fed under former Chairman Alan Greenspan "cut the funds rate to 1 percent and left it there for a year, they kept saying rates would remain low for a considerable period of time," Jones said.

"I think this time rates will stay at 1 percent for a longer period."

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