Fed cuts benchmark rate by one-quarter point

Posted in United States | 12-Dec-07 | Author: Louis Uchitelle| Source: International Herald Tribune

Traders gather to watch the Fed interest rate decision as they work on the New York Stock Exchange trading floor, Tuesday Dec. 11, 2007.

WASHINGTON: The Federal Reserve cut its benchmark short-term U.S. interest rate Tuesday by a quarter of a percentage point, to 4.25 percent, signaling its concern that a credit crisis might be gradually damaging the broader economy beyond housing.

Policy makers also cut the discount rate, the interest on the Fed's loans to banks, to 4.75 percent from 5 percent, essentially encouraging bankers to turn to borrow from the central bank to keep up their lending to consumers and businesses.

The cut in the benchmark federal funds rate came at a meeting of the Fed's policy makers in Washington. It was the third consecutive cut at these periodic meetings since the credit crisis erupted in August.

The federal funds rate governs the cost of overnight loans that banks and other lending institutions make to each other. Consumer credit, mortgage rates and auto loans all fluctuate with changes in the federal funds rate, which was 5.25 percent when the credit problems began.

The rate cut comes as the Federal Reserve struggles to deal with a weakening economy, with no one sure how much damage the tight credit market might do.

The Fed's policy makers suggested in late October that they might have done enough. By then, they had cut the federal funds rate, in two steps, by three-quarters of a percentage point, to 4.5 percent.

And there the matter stood until late November when the Fed's top policymakers - Ben Bernanke, the chairman, and Donald Kohn, the vice chairman - signaled that there would be another rate cut, at Tuesday's meeting.

In speeches a day apart, the two men expressed concern that subprime mortgage problems might be making banks and other lenders reluctant to lend, not only for housing but for other activities as well.

There is a crucial question for central bankers, Kohn declared, and that is "what is happening to credit for other uses, and how much restraint are financial market developments likely to exert" on the willingness of banks and other lenders to offer credit to consumers and to business.

The cut Tuesday in the rate at which financial institutions lend money to each other for very short periods might not end that reluctance to lend, some economists say, and that could push a still-growing economy toward recession.

Housing is by far the weakest sector. Home sales are down and prices have fallen not just on the East and West Coasts of the United States, as they did in previous slumps, but in almost every region. Consumer spending has been less than robust in the opening weeks of the holiday shopping season, but well above the recession levels in the first two years of the decade.

Corporate profits, which had held up well through most of the decade, are showing signs of retreat, and some economists say that capital spending on new machines and equipment might also be weakening. Job growth has clearly weakened in the last two years, but not drastically. Employers added 127,100 jobs a month, on average, over the past year, despite the tight credit market, and the unemployment rate held below 5 percent.

A big concern is economic growth, which surged to an annual rate of 4.9 percent in the third quarter and now, by most estimates, is slowing to 1 percent or less in the last three months of the year, and perhaps less in next year's first quarter.

"A mild recession is now likely, with no growth for the year ahead," Richard Berner, chief domestic economist at Morgan Stanley, declared this week in a report to clients.

But others see an economy with an underlying growth rate of 2 percent to 2.5 percent. They argue that the surge in the third quarter and this quarter's sharp slowdown are exceptions on either side of a growth trend not yet affected by the tight credit market.

"Take out trade and inventories, and real final sales to domestic buyers, including business investment, is 2.4 percent," the chief domestic economist at Global Insight, Nigel Gault, said.

German confidence declines

German investor confidence has dropped to its lowest level in nearly 15 years, weighed down by worries over the global economic outlook and the impact of the strong euro, a survey showed Tuesday, The Associated Press reported from Berlin.

The ZEW institute's index, which measures investors' expectations over the next six months for Germany, Europe's biggest economy, dropped to minus 37.2 points for December from minus 32.5 last month.

That was the worst showing since January 1993, when the index stood at minus 49.7, and also came in below the minus 34 forecast of economists surveyed by Dow Jones Newswires.

"The financial market experts see clear risks for economic growth in important industrial countries, particularly in the United States," ZEW said. "This impairs the export prospects of the German economy. The strong euro has furthermore increased uncertainty for German exporters."