Fed cuts key rate again to avert a deeper crisis

WASHINGTON - The Federal Reserve yesterday slashed a key interest rate by three-quarters of a percentage point, an aggressive step aimed at containing a credit crisis threatening to push the country into a severe recession.

The step lowered the federal funds rate - the interest banks charge one another on overnight loans - to 2.25 percent, the lowest since late 2004. It marked the second cut of three-quarters of a percentage point this year. The first occurred at an emergency meeting Jan. 22 and was followed by a half-point cut at a regular meeting Jan. 30.

However, there has been opposition inside the Fed to the aggressive moves. Yesterday's rate cut came on an 8-2 vote of the Federal Open Market Committee.

Charles Plosser, president of the Federal Reserve Bank of Philadelphia, and Richard Fisher, president of the Dallas regional Fed bank, voted against yesterday's reduction, arguing they would have preferred less aggressive action.

Fed Chairman Ben S. Bernanke and his colleagues have now cut the funds rate six times since September, with the reductions becoming more aggressive since January as the central bank has faced growing turmoil in global financial markets.

In explaining its actions, the Fed said it was having to navigate a difficult policy environment that included sluggish economic activity and rising inflation pressures.

The Fed statement said "the outlook for economic activity has weakened further," but "inflation has been elevated," with some signs that expectations of future inflation pressures are rising, a dangerous sign for the Fed.

But the Fed signaled it stood ready to cut rates further if necessary, saying "downside risks to growth remain."

Bernanke and other Fed officials have commented recently that they view the threat of economic weakness as a bigger risk at the moment than inflation - that is, a general increase in prices across the economy - given the risks to financial markets.

While the cut was larger than the Fed's normal quarter-point moves, investors initially were disappointed that the central bank did not cut rates by a full percentage point.

The Dow Jones industrial average had been up 286 points just before the announcement, a rally prompted by the morning release by Lehman Bros. Holdings Inc. and the Goldman Sachs Group Inc. of better-than-expected earnings results for the first quarter.

After the Fed announcement, the Dow immediately pulled back 100 points. But it soon resumed climbing and ended up 420 points, or 3.5 percent. The Standard & Poor's 500 and the Nasdaq composite index were up more than 4 percent each.

The reduction in the funds rate was designed to lower borrowing costs and boost spending by consumers and businesses and thus increase economic activity.

The funds rate cut quickly triggered announcements from commercial banks that they were cutting their prime lending rate to 5.25 percent from 6 percent, where it was before the Fed meeting. This rate is the benchmark for millions of business and consumer loans.

From yesterday's Federal Open Market Committee statement on the economy and interest rates:

Growth in consumer spending has slowed and labor markets have softened.

Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

[Yesterday's rate cut] . . . should help to promote growth over time. However, downside risks to growth remain.

Inflation has been elevated . . . It will be necessary to continue to monitor inflation developments carefully.

Charles Plosser,

right, president of the Philadelphia Fed, and Richard Fisher, president of the Dallas Fed, were the only committee members who voted against the rate cut. Neither commented yesterday.

Plosser

, however, expressed concern March 3 about rate cuts fueling inflation:

"Once the genie is out of the bottle, it's hard to get it back in. . . . We can't wait too long for inflation expectations to materialize, otherwise we'll get behind the curve."

SOURCE: The Market Wire