Fed slashes US rates to blunt economic slowdown

The cumulative 1.25 percentage point reduction in the interbank overnight rate in less than two weeks ranks among the most abrupt rate-cutting sprees in the modern history of the US central bank.

“The Fed has clearly decided that pulling out all stops to stabilize financial markets represents its main priority,” said Lena Komileva, an economist at Tullett Prebon in London.

The vote to lower rates, which was widely expected, was not unanimous. Dallas Federal Reserve Bank President Richard Fisher dissented, preferring to hold borrowing costs steady.

US. stock markets initially rallied in response to the rate cut, but renewed credit crunch fears erased the gains by the close. The Dow Jones industrial average finished down 37 points at 12,442. The dollar also moved lower, as did prices for longer-dated US bonds, which are sensitive to inflation.

Risks to growth remain

The Fed said its rate-cutting campaign, which has brought borrowing costs down from 5.25 percent in five steps dating to mid-September, should help thwart the risk of recession, but it left the door open to future moves.

“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,” the Fed said.

Still, when the Fed lowered rates on Jan. 22 it had cited ‘appreciable downside risks to growth.’ Analysts said the omission of the word ‘appreciable’ in the latest statement suggests officials feel more comfortable having acted boldly.

“The Fed is demonstrating that they are getting ahead of the curve,” said Jeff Kleintop, chief market strategist at LPL Financial Services in Boston. “Maybe they feel that now, with this latest policy action, they have taken the worst-case scenario of a deep recession off the table.”

Market participants anticipate as much as a 52 percent chance the Fed’s next move will be another half point rate cut, as implied by short-term interest rate futures.

A Reuters poll of 16 top Wall Street dealers, found that 15 expect the central bank to lower borrowing costs again at its next meeting in March, although views were split on the size of the move.

Vicious credit cycle

The Fed’s action came on the heels of a government report showing that the economy grew at a weak 0.6 percent annual pace in the last three months of 2007 as consumers curbed spending and homebuilding plunged. Growth of 2.2 percent for all of 2007 marked the economy’s weakest expansion in five years.

At the same time, a report showing private-sector employers added three times as many jobs as expected in January and a report earlier this week showing a big rise in orders for US-made durable goods pointed to some economic resilience.

With a burst of aggressive rate cuts, the Fed is displaying its predilection for taking preventive action to halt what might become a vicious cycle of tighter credit or financial market turmoil amplifying a slowdown in economic activity.

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

However, the central bank also repeated that it would be monitoring inflation developments carefully, even though it expects inflation to moderate in coming quarters.

In August, rising defaults on US subprime mortgages led to a seizing up of credit markets. While conditions have improved, aftershocks from the subprime mortgage crisis have continued and financial markets remain volatile.

At the same time, the housing market continues to plummet. Sales of new single-family homes fell 4.7 percent in December to their lowest level since 1995, the government said on Monday. For all of 2007, sales were off a record 26 percent.