Fed Action Raises Hopes Of More Relief

Source : The Straits Times, Sunday, Aug 19, 2007

More interest rate cuts are expected to help banks deal with the spreading global crisis

WASHINGTON - A DRAMATIC cut in the Federal Reserve's discount rate sent stocks soaring on Friday, but the spreading global credit crisis means the Fed will almost certainly have to do more.

A cut in the more important federal funds rate is expected to follow in short order as the central bank battles to keep the economy out of recession.

Some economists think the Fed could engineer more interest rate reductions at each of its three remaining meetings this year, the first of which will be held on Sept 18.

Friday's move by Federal Reserve chairman Ben Bernanke will give banks access to sorely needed funds by cutting the discount by a half-point to 5.75 per cent. That is the interest rate the Fed charges banks for direct loans.

The Fed's action is being seen as a way to prod banks to step up their short-term lending in the face of near paralysis in many debt markets.

The credit crisis began with rising defaults on sub-prime mortgages, loans made to borrowers with weak credit.

Cutting the discount rate will not have an impact on consumer interest rates in the way that cutting the federal funds rate can achieve in triggering an immediate drop in banks' prime lending rate, the benchmark for millions of consumer and business loans.

However, Friday's move will allow banks to deal with the severe credit crunch by making it easier for them to make loans to businesses.

It marked the Fed's first change in rates between regularly scheduled meetings since Sept 17, 2001, when the central bank was struggling to get financial markets back into operation after the terrorist attacks on the World Trade Center.

But observers believe that even more important than what the Fed did on Friday was what it said.

In a brief statement, Mr Bernanke and his colleagues on the Federal Open Market Committee said they judged that 'the downside risks to growth have increased appreciably' and they were 'prepared to act as needed to mitigate the adverse effects on the economy arising from disruptions in financial markets'.

That statement was seen as a clear signal that the Fed had moved its 'bias' - which signals the next direction for interest rates - from seeing inflation as the biggest economic threat to concern about weak growth.

Fed worries about inflation mean possible interest rate increases, while worries about growth mean possible rate cuts.

The new wording marked a significant shift from just 10 days ago.

'The Fed was behind the curve in dealing with this crisis before today. Now they are even with the curve,' said Mr David Jones, chief economist at DMJ Advisers, an economic consulting firm.

'They now have a better chance of mitigating the damage from an all-out global credit crisis.'

Following the Fed's decision, Japanese papers reported yesterday that Japan is now unlikely to raise interest rates at a policy board meeting this week.

Although many Bank of Japan policy board members are showing signs that they will watch moves in financial markets right up until the BOJ Aug 22-23 policy meeting, the central bank seems likely to hold off from raising rates at that time, the Nikkei business daily said.

Meanwhile, in another development, Sentinel Management Group Inc, a cash management firm serving the US futures industry whose decision to freeze client accounts on Tuesday helped roil global financial markets, filed for Chapter 11 bankruptcy protection late on Friday.-AP, Reuters