The US Federal Reserve decided on Tuesday to cut a key interest rate by a half percentage point to 4.75% in an effort to calm down turmoil in the credit markets and avoid a broader economic downturn.
This was the first cut in the central bank’s target for the federal funds rate, the interest rate that commercial banks charge each other for overnight loans, in more than four years. The aggressive half-point rate reduction was designed to boost economic growth by lowering borrowing costs for millions of consumers and businesses. Commercial banks are expected to quickly match the Fed’s action by cutting their prime lending rate, which has been at 8.25% for the past 15 months. In addition to the drop in the target rate, the Fed also reduced its discount rate, the interest it charges in making direct loans to commercial banks, by a half percentage point as well to 5.25%.
Before Tuesday’s decision, the Federal Reserve had injected more than $140 billion into the financial system since Aug. 9 to increase liquidity to help beat back the credit crisis. On Aug. 17, the Fed approved a half point cut in its discount rate, down to 5.75% from 6.25%, to “promote the restoration of orderly conditions in financial markets.” In a brief statement announcing the rate cut decision, the Fed said that Tuesday’s action “is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time. Economic growth was moderate during the H1 of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally,” it explained. It also said that developments in financial markets since the Fed’s last regular meeting on Aug. 7 have increased the uncertainty surrounding the economic outlook.
The Fed will continue to assess the effects of these and other developments on economic prospects and will “act as needed” to foster price stability and sustainable economic growth, it vowed. Meanwhile, the Fed said readings on core inflation have improved modestly this year. However, it judges that “some inflation risks remain,” and it will continue to monitor inflation developments carefully. At present, many economists believe the Fed will have to cut rates again, perhaps more than once more, before markets and the economy are back on a stable path. Some think the Fed may have to keep cutting into 2008, according to a report by the Wall Street Journal on Monday.
One problem is that some Fed policy makers still appear concerned about the risk of inflation, and it is uncertain how many times they will be willing to cut rates. During the H1 of this year, overall inflation, including energy and food, was running at an annualized rate of 2.5%, down from 3.2% in 2006. The Fed has leeway to act and restore confidence, some analysts say. Even if the Fed carries out a series of rate cuts, however, the economy and stock market are likely to be dealing with the fallout from the current problems well into the next year, others believe.
Crude prices surged to another record high near $82 dollars a barrel on Tuesday on concerns over tight supply in the United States. A Federal Reserve decision to cut interest rates by 50 basis points also supported oil and other commodities. Light, sweet crude for October was up 95 cents at 81.51 a barrel after hitting a record $81.90 earlier in the session. London Brent crude was up 54 cents at $77.52. (people.com.cn)