Fed Slashes Interest Rates Again As Economy Stalls

Jan 30, 04:10 PM

The Fed reduced its federal funds rate _ the overnight rate banks charge each other _ to 3 percent. Commercial banks mirrored that move, lowering their prime rate _ which they charge their best borrowers _ to 6 percent. The Fed also made a half-point cut to the rate it charges banks for emergency borrowing.

When the Fed began lowering rates last September, its benchmark rate was 5.25 percent and the prime rate was 8.25 percent.

Usually, lower rates make it cheaper to take out a car loan, pay off credit card debt or buy inventory for a small business. But turbulent credit markets and a deep slump in the housing sector may mute some of the benefits of the rate reductions, whose effects in any case won't felt across the broader economy for months. Banks and other lenders have become reluctant to lend to anyone but borrowers with impeccable credit histories.

The Fed alluded to this in its statement.

"Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," it said. "Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets."

The statement left open the possibility of more rate cuts in the months ahead.

"Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain," it said.

Commerce Department economic-growth data released Wednesday underscored how much housing is hurting the broader economy. Investment in residential housing fell by the largest quarterly amount since 1981, and that's offsetting the Fed's efforts to jumpstart the economy.

"The principal link between monetary policy and the economy is the housing market, and this link is being short-circuited by the housing recession," said Mark Zandi, the chief economist for Moody's Economy.com, a forecaster in West Chester, Pa.

The Fed's reductions came on the heels of an unusual emergency three-quarters of a percentage point reduction in the federal funds rate on Jan. 22. Faced with deep drops in stock markets across the globe and anticipation of similar slides in the United States, Chairman Ben Bernanke took dramatic action.

The reasons for his concern became clear Wednesday morning, when the Commerce Department data showed that economic growth in the fourth quarter of last year slowed to a tepid 0.6 percent.

That's about half of what most mainstream economists had forecast, and it's the slowest rate in five years. It suggests that the economy had virtually no tailwind going into what's been a volatile new year so far. The economy had ground nearly to a halt in the last quarter, and it dragged the full-year growth rate for 2007 to just 2.2 percent, compared with 2.9 percent for 2006.

President Bush and Congress are rushing to put together an economic stimulus plan, hoping that the combination of tax rebates for consumers and tax breaks for businesses will spur consumer spending, which drives two-thirds of U.S. economic activity.

The $150 billion stimulus measure passed the House of Representatives on Tuesday, but the Senate began modifying the plan Wednesday to provide economic assistance to the poor and elderly, possibly putting the two chambers at odds and raising the prospects of a presidential veto and delay.

Wednesday's economic data underscored why quick passage of a stimulus plan is so important.

The new data confirm that consumer spending is slowing and that consumers have less money left over after meeting their basic needs.

Consumer spending rose by 2 percent in the fourth quarter, down from 2.8 percent in the third quarter. It contributed 1.37 percentage points to economic growth in the fourth quarter, down from 2.01 percentage points in the third quarter. Real disposable personal income grew by just 0.3 percent, well off the 4.5 percent increase during the previous quarter.

The troubled housing sector negated almost all gains from consumer spending. Investment in residential housing fell 24 percent from October through December, shaving an estimated 1.18 percentage points off the economic growth rate.

In previous quarters, growing U.S. exports had offset the negatives from housing. But in the fourth quarter, exports contributed less than half a percentage point to the economic growth rate.

The biggest surprise in Wednesday's important data was that business inventories fell during the last three months of last year. In the past, such a drop was a sure sign of recession. But inventory management has grown more precise in recent years, and the drop in inventories can be seen as a glass half full: It could signal that companies already are well positioned to operate in a slower economy.

"The inventory drawdown was nearly all in vehicle inventories. The auto manufacturers won't be building (more of) them anytime soon," Zandi said. "Inventories elsewhere aren't over-laden but not lean either. Inventory changes are unlikely to play a role in determining overall growth during the first half of the year."

Whether the economy grows slowly or gets mired in recession depends on how businesses spend and hire. December's weak employment numbers led many economists to increase the chance of recession, and the eyes of Wall Street and Main Street now turn to the Labor Department's release of January employment data on Friday.

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(c) 2008, McClatchy-Tribune Information Services.

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GRAPHICS (from MCT Graphics, 202-383-6064): 20080130 FED rates and 20080130 GDP

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