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Fed cuts rates by half-point, third reduction this year

WASHINGTON (AP) – The Federal Reserve slashed a key interest rate by a half-point Tuesday, hoping to encourage Americans to spend and invest to revive a sluggish economy.

It marked the third time this year that the central bank cut interest rates, a move that lowers borrowing costs and aims to gin up demand, which eventually should boost economic growth. All three reductions were one-half point.

The Fed cut its target for the federal funds rate – the interest that banks charge each other on overnight loans – from 5.5 percent to 5.0 percent. That’s the lowest since June 30, 1999, when the funds rate also stood at 5.0 percent.



The half-point cut disappointed Wall Street, which last week suffered through a huge sell-off as investors grew more pessimistic about economic prospects in the United States and its major trading partners. They were hoping for a three-quarter-point cut.

On Wall Street, stocks skidded, leaving the Dow Jones industrial average at its lowest level in two years. The Dow lost 238.35 points to close at 9,720.76. The last time the Dow closed lower was March 24, 1999, when it dropped 154.90 to 9,666.84. The Nasdaq composite index tumbled 93.72 points to 1,857.46, a closing low not seen since November 1998.




The Fed attributed the economy’s weakness in part to production cutbacks at factories in the face of flagging demand.

”Excess productive capacity has emerged recently. The possibility that this excess could continue for some time and the potential for weakness in global economic conditions suggest substantial risks that demand and production could remain soft,” the Fed said in a statement, explaining its decision to cut rates again Tuesday.

With the Fed offering a list of concerns about the economy and the next scheduled meeting not until May 15, some economists believe the odds are high that the central bank may cut rates again before then.

”That all suggests that the door is open to an inter-meeting cut if any of those downside economic risks become of more concern,” said Allen Sinai, chief economist at Decision Economics.

The decision came after a closed-door meeting of the Fed’s chief policymaking group, the Federal Open Market Committee. The panel includes Fed Chairman Alan Greenspan, Fed governors and five of the 12 presidents of Federal Reserve banks.

The White House declined to comment on the Fed’s decision to cut rates by a half point, rather than a bolder, three-quarters point. Spokesman Ari Fleischer said: ”The White House does not engage in any such speculation on the action of the Fed.”

Sen. Charles Grassley, R-Iowa, who chairs the Senate Finance Committee, however, was disappointed. ”It should have been more,” he said.

But National Association of Manufacturers President Jerry Jasinowski, whose industry is bearing the brunt of the economic slowdown, called the half-point cut a ”very helpful step toward bringing the economy out of troubled waters.”

The Fed’s half-point decrease in the funds rate was quickly followed by an announcement from Bank of America that it was reducing its prime lending rate by a half-point, to 8 percent, effective Wednesday. Other commercial banks were expected to do the same.

The prime rate is the key benchmark for millions of loans, from home equity and unpaid credit-card balances to short-term loans for small businesses.

The central bank also reduced its symbolic discount rate, the interest that the Fed charges to make direct loans to banks, by a half-point to 4.50 percent.

Looking ahead, the Fed said its chief concern remains the threat the economy will stall and fall into recession.

”The risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future,” the Fed said.

Given the backdrop of a weak U.S. economy and economic turmoil overseas, the Fed said it ”will need to monitor developments closely.”

The Fed cut interest rates twice in January, totaling a full percentage point. That was the biggest one-month decrease in rates since Greenspan took over in 1987. The first reduction came on Jan. 3, in a rare move between regularly scheduled meetings and the second cut came on Jan. 31.

Tuesday’s rate cut comes against the backdrop of a faltering U.S. economy, a sliding stock market and economic troubles overseas, especially in Japan, the world’s second-largest economy.

U.S. manufacturing activity has plunged and the mood of consumers, whose spending accounts for two-thirds of all economic activity, is cautious.

The huge sell-off on Wall Street, where the Dow Jones industrial average last week suffered its biggest weekly drop in 11 years, is another reason for concern.

With nearly half of all American households owning stock directly or indirectly, paper losses could make consumers feel a lot less wealthy and they could stop spending. That could put an end to the nation’s record-long 10-year streak of uninterrupted economic growth, analysts say.

The Fed, in its statement, said that ”persistent pressures on profit margins are restraining investment spending, and through declines in equity wealth, consumption.”

Still, there are some positive signs for the economy, including: a solid housing market, aided by cheaper borrowing costs; still-low unemployment, which stands at 4.2 percent; and modest job growth, economists say.

The Fed’s January rate cuts came after the economy appeared to hit a brick wall at the end of last year, when unusually cold weather and rising energy bills sent consumer spending into a tailspin. However, in the first two months of this year, consumer spending has rebounded, easing some economists’ fears of a recession.

On the Net:

Federal Reserve: http://www.federalreserve.gov


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