Fed cuts interest rate amid global stock sell-off and fears of recession
Published 6:29 pm Tuesday, January 22, 2008
The Federal Reserve, confronted with a global stock sell-off fanned by increased fears of a recession, slashed a key interest rate by three-quarters of a percentage point on Tuesday and indicated further rate cuts were likely.
The surprise reduction in the federal funds rate from 4.25 down to 3.5 percent marked the biggest one-day rate move by the central bank since it cut its discount rate by a full percentage point in December 1991, a period when the country was struggling to get out of a recession.
Analysts said the Fed will likely delay cutting rates further at its Jan. 29-30 meeting but will probably keep moving rates down aggressively as the economy continues to weaken.
“This move is not an instant fix,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics. “The economy is still staring recession in the face, but at least the Fed now gets it.”
In addition to cutting the funds rate, the Fed said it was reducing its discount rate, the interest it charges to make direct loans to banks, by a similar three-quarters of a percentage point, pushing this rate down to 4 percent.
Commercial banks responded to the Fed’s action on the funds rate by announcing similar cuts of three-quarter of a percent on its prime lending rate, the benchmark for millions of business and consumer loans. The action will mean the prime lending rate will drop from 7.25 percent down to 6.50 percent.
The Fed action was the most dramatic signal it can send that it is concerned about a potential recession in the United States.
The Fed decision was taken during an emergency telephone conference with Fed officials on Monday night. Those discussions occurred after global financial markets had plunged Monday as investors grew more concerned about the possibility that the United States, the world’s largest economy, could be headed into a recession.
In a brief statement, the Fed said it had decided to cut the federal funds rate “in view of a weakening of the economic outlook and increasing downside risks to growth.”
The central bank said that the strains in short-term funding markets have eased a bit, but “broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.”
The move caught financial markets by surprise. Many had expected the central bank would wait until its meeting next week to make any move in interest rates. The Fed made the move before markets had opened in the United States, hoping that the bold move would limit the decline in U.S. stocks.
Before Tuesday’s move, the Fed had cut interest rates three times, beginning in September, the month after a severe credit crunch had roiled Wall Street and global financial markets. The Fed cut the funds rate by a half-point in September and then by smaller quarter-point moves in October and December.
In its statement, the Fed said, that “appreciable downside risks to growth remain” and held out the prospect of further rate cuts.
“The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risk,” the Fed statement said.
The Fed’s action was approved on an 8-1 vote with William Poole, president the Fed’s regional bank, dissenting. The statement said that Poole objected because he did not believe current conditions justified a rate move before the Fed’s meeting next week.