Fed Ready To Lower Rates This Week

Source : The Straits Times, Sep 17, 2007

WASHINGTON - FOR the first time in more than four years, the Federal Reserve appears ready to lower interest rates to prevent a housing meltdown and a painful credit crunch from driving the US economy into a recession.

A rate cut would affect millions of American borrowers, with the intention of getting them to spend and invest more, which would revitalise the US economy.

In one of their most important and anxiously awaited decisions, Fed Chairman Ben Bernanke and his central bank colleagues meet on Tuesday to determine their next move on interest rates. Those policymakers are widely expected to cut an important rate, now at 5.25 per cent, by at least one-quarter of percentage point. Some analysts predict a bolder step, a half-point reduction.

If the Fed drops the rate, then the prime lending rate that commercial banks charge many individuals and businesses would fall by a corresponding amount. It now is at 8.25 per cent.

Mr Bernanke repeatedly has pledged in recent weeks to 'act as needed' to keep the housing and credit mess from sinking the economy.

'Bring out the big gun'
'It seemed like the Fed was behind the curve. Now it is going to bring out the big gun' on Tuesday and cut its most important rate, the federal funds rate, said Scott Anderson, economist at Wells Fargo.

The last time the funds rate, which is the interest that banks charge each other, was lowered was in late June 2003. The rate is the Fed's main tool for influencing the economy. On Aug 17, the Fed slashed its lending rate to banks and issued a more grim assessment of the economic climate.

'It's no longer a debate over whether they will ease but by how much,' said Mark Zandi, chief economist at Moody's Economy.com.

'The economy is soft and getting softer,' and the Fed has come under economic and political pressure to act.

Should the Fed go with a quarter-point cut, analysts expect policymakers will lower the rate again in October and in December, their final meeting of the year.

Fed action would mean that borrowers who can obtain credit would see rates drop on a variety of loans. It would become less expensive for people to finance certain credit card debt and for homeowners to take out popular home equity lines of credit, which often are used to pay for education, home improvements or medical bills.

Help some homeowners
Also, it should help some homeowners whose adjustable-rate mortgages reset in the fall.

'Borrowers facing a rate reset Oct 1 might see their ARM rates adjust to 6.7 per cent, for example, rather than the 7.5 per cent that a borrower whose loan adjusted back on July 1 experienced,' said Greg McBride, senior financial analyst for Bankrate.com. 'Still a big increase, but not the knockout punch it could have been,' he said.

Less immediate would be relief for America's economic health. An expected series of rate decreases could take three months to nine month before rippling through the economy and bolstering activity.

'It's like taking an antibiotic. After you take the first dose, you don't feel immediately better. But after a series of dosages accumulate, there will be a more positive effect,' explained Stuart Hoffman, chief economist at PNC Financial Services Group.

Psychological boost
Over the short term, a rate cut would provide an important psychological boost. It could make investors, businesses and others less inclined to clamp down or make drastic changes in their behaviour that would hurt the economy.

Fears that the deepening housing slump and a spreading credit crisis could short-circuit the six-year-old economic expansion have shaken Wall Street over the past few months. Stocks have swung wildly, with sharp drops reflecting investors' bouts of panic.

A recent government report showing that the economy lost jobs for the first time in four years delivered a fresh jolt. The biggest fear is that individuals and businesses will cut back on spending, throwing the economy into a tailspin.

Former Federal Reserve Chairman Alan Greenspan, in an interview broadcast Sunday on CBS' '60 Minutes,' said he believes the economy will be able to weather the financial storm.

'For the moment it does not look sufficiently severe that it will spiral into anything deeper,' he said. 'We're going to get through this particular credit crunch. We always do. This is a human behaviour phenomenon, and it will pass. The fever will break and euphoria will start to come back again.' By Mr Zandi's odds, there now is a 40 per cent chance the US economy will fall into a recession - the highest probability since the last recession, in 2001. Just two months earlier, Mr Zandi believed there was only a 12 per cent chance.

So far, though, American consumers have not cracked. Retail sales rose a modest 0.3 per cent in August, after a 0.5 per cent gain in July, the government reported on Friday.

Analysts expect the economy will slow to a rate of about 2 per cent in the current quarter, from July through September. That would be just half the rate of the three previous months. Growth in the final three months of this year could turn out even weaker.

Jobless seen rising
The employment climate is starting to deteriorate. Employers eliminated 4,000 jobs in August, intensifying calls by politicians and others for the Fed to cut rates. The unemployment rate, now at 4.6 per cent, is expected to climb close to 5 per cent by the year's end.

The weakness in employment was troubling because job and wage growth have served as shock absorbers for people coping with the housing slump.

After a five-year boom, the housing market went bust more than a year ago. Higher interest rates and weaker home values clobbered homeowners, particularly 'subprime' borrowers with spotty credit histories or low incomes. Foreclosures set records and late payments spiked. Lenders were forced out of business. Hedge funds and other investors in subprime-related mortgage securities took a huge financial hit.

A credit crisis ensued, spreading beyond the subprime market to more creditworthy borrowers. -- AP