Fed Cuts Rates Once Again
Though many economists speculated earlier this week that the Federal Reserve Board was done cutting rates, chairman Ben Bernanke announced another cut today. The Fed cut its key interest rate by a quarter percentage point, but the central bank's statement revealed that this may be the last rate cut for some time.
The cut took the key overnight rate at which banks loan money to each other (the federal funds rate) to 2%. In September 2007, this rate had been at 5.25%. That was when the Fed began slashing rates in an attempt to spur the economy and prevent a national recession.
This rate is a benchmark for home equity lines of credit, credit cards, and consumer loans in addition to being the prime rate used for short-term business loans.
The Fed's statement today echoed earlier statements about how rate cuts up to this point should help strengthen the economy and lessen the risk of economic downturn. The central bank, however, removed the claim that "downside risks to growth remain," from its statement.
The exclusion of this phrase and the central bank's new comment that "uncertainty about the inflation outlook remains high" lead some economists to believe that the central bank is signaling its readiness to keep rates stagnant for a while.
Mark Zandi, chief economist for Moody's Economy.com, says, "they haven't closed the door to further cuts, but they've shut it part way. They're saying they believe they've done enough."
Immediately following the Fed announce, stocks surged but later would up giving all gains and finished the day lower, which signs that investors are still concerned about the weak economic environment. Government reports earlier this morning announced that the economy grew by just 0.6% in the first quarter of 2008, an unimpressive growth but not low enough to signal an economic recession.
The Fed is not scheduled to meet again until June 24 & 25, the longest break in its 2008 calendar. Zandi believes that a pause is the proper action for the Fed to take at this point. Zandi believes that the Fed has done a lot and that "they sense the financial system is on firmer footing. The economy is still weak, but the pace of decline doesn't seem like it's accelerating."
Keith Hembre, chief economist for First American Funds, believes that, should the U.S. economy get any weaker, the central bank will start cutting rates again either later this year or early 2009. "The Fed has certainly done a lot so far, but I think six months down the road we'll find that the economy is not rebounding as we've anticipated and the Fed will have to move rates lower." Hembre's prediction for the future is exactly what happened during the last period of Fed rate cuts when it began slashing throughout 2001, taking the fed funds rate to 1.75%. After lowering rates that much, the Fed kept rates on hold during most of 2002 but cut them again in November of that year and once again in June 2003, bringing the rate to 1%.
Some believe that a simple solution to inflation is raising rates, or doing just the opposite of the Fed's plan of action. Rich Yamarone, director of economic research at Argus Research, does not think that rates will get as low as they were in 2002. He thinks that the Fed's next move will be to raise rates in order to battle building inflationary pressures. He notes that the real fed funds rate (the fed funds rate minus the inflation rate) is now negative 1.27%.
Yamarone says, "policymakers know all too well that when real rates are negative for an extended period of time, inflation pressures rise swiftly and dramatically." He added that the Fed could begin raising rates as soon as December.
More and more complaints have surfaced about the Fed's aggressive rate cuts this year, saying that they have caused the skyrocketing of food and oil prices. The fact that the Fed has cut its rates while central banks in Asia and Europe have kept steady rates has led to a weakening of the U.S. dollar, which in turn has driven up commodity prices.
"The Fed will be reluctant to cut any further, because inflation remains elevated, and they do not want inflationary expectations to increase," said Arun Raha, senior economist for Swiss Re.
Two of the presidents of Fed district banks who sit on the rate-setting Federal Open Market Committee (Richard Fisher of Dallas and Charles Plosser of Philadelphia) voted against today's rate cut. These two men also voted against the half-point cut made on March 18, 2008. The Fed's statement said that both Fisher and Plosser preferred no change in rates. The two of them did vote for a quarter-point cut in the discount rate, however. The discount rate is the rate at which the Fed lends money to commercial banks.
