Fed Cuts Base Rate By A Quarter-Point To 4.50%

Source : The Business Times, 01 November 2007

WASHINGTON : The Federal Reserve cut US short-term interest rates on Wednesday in a widely anticipated move, saying it had acted amid concerns economic growth will likely cool in coming months.

The central bank said it had cut its federal funds interest rate by a quarter of a percentage point to 4.50 percent. Wall Street shares closed with a rally in the wake of the announcement.

"The pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction," the Fed said in a statement.

The Fed slashed borrowing costs on September 18 by a more dramatic half a percentage point, but the housing slump - one of the worst in decades - has shown no sign of improvement.

"The concerns over housing and credit seem to be dominant for most of the FOMC (Federal Open Market Committee) and their evaluation today," said Carl Tannenbaum, a chief economist at ABN AMRO North America, Inc.

The Fed said policymakers, led by Fed chairman Ben Bernanke, had reduced rates in an effort to keep the world's largest economy growing at a "moderate" pace.

The decision was not unanimous, however, as Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, voted to keep the fed funds rate pegged at 4.75 percent.

Hoenig was heavily outvoted by nine other policymakers including Bernanke who all wanted to trim borrowing costs.

The central bank's move, its second rate cut in as many months, will also offer some relief to ailing credit markets which have tightened as major commercial banks have sustained hefty losses tied to mortgage-backed securities.

"This action will help to stabilise the financial markets," said Brian Bethune, a US economist at Global Insight.

Merrill Lynch, one of Wall Street's biggest investment banks, announced vast write-downs of almost eight billion dollars last week, mainly related to soured bets on mortgage securities.

"There are still sectors of the credit markets that are not functioning very well. Very simply stated, if capital is not flowing, then firms are more hesitant to make investments," Tannenbaum said.

The fresh rate cut is also likely to be appreciated by consumers who will benefit from lower borrowing costs, but it dealt a fresh blow to an already weakened dollar.

The euro leapt to a record high of 1.45 dollars in the wake of the Fed's move. The dollar's decline on foreign exchange markets makes foreign goods and products, particularly oil, more expensive for Americans to purchase.

The Fed statement cited concerns about rising energy and commodity prices, saying they could renew inflationary pressures, but economists said housing and credit worries outweigh inflation risks for now.

Crude oil prices have rocketed in recent weeks and leapt to a new record high of 94 dollars a barrel in New York on Wednesday amid supply concerns and geopolitical angst.

Although US economic growth has been robust in recent months, economists fear growth could slow markedly in coming months, largely because of the housing downturn.

"As we struggle to find a new equilibrium for home prices are consumers who are seeing the values of their properties diminish going to adjust their spending patterns?" Tannenbaum said.

Sales of existing homes and apartments dived eight percent in September to a seasonally adjusted rate of 5.04 million properties. Sales and home prices have plummeted as a glut of unsold properties has flooded the market.

Other economic gauges are throwing off lacklustre readings despite a government report on Wednesday which showed third-quarter growth accelerated a notch to 3.9 percent.

The central bank also cut its discount rate, the rate it levies on loans to commercial banks, by a quarter of a percentage point to five percent. - AFP/de