Interest rate cut leads to US markets strengthening

The US cut a key interest rate for the first time in four years.

Photo: Interest rate cut leads to US markets strengthening

The half-point cut by the Federal Reserve was aimed at preventing a steep housing slump and turbulent financial markets from triggering a recession.

The Fed announced that it was reducing its target for the federal funds rate, the interest that banks charge each other, from 5.25% to 4.75%.

The half-point reduction was double the quarter-point move that many economists had been expecting.

The action was designed to boost economic growth by lowering borrowing costs for millions of consumers and businesses, the AP reports.

Stocks immediately soared. The Dow Jones industrial average registered its biggest one-day gain in almost five years, closing at 13,739.39, up 335.97, or 2.5 percent. The Standard & Poor’s 500-stock index rose nearly 3 percent.

For consumers, the Fed’s move could mean lower borrowing costs on for mortgages and automobile loans. But the impact may be muted, because investors remain deeply anxious about the credit quality of mortgages and other long-term loans. The main problem in the past month has not been high rates so much as the availability of capital to complete deals.

In a separate move to bolster the banking system, the Fed also said today that it had cut its discount lending rate, which applies to short-term emergency loans to banks, to 5.25 percent — also a half-point cut.

This was the Federal Reserve’s most abrupt reversal of course since January 2001, when it suddenly slashed rates at an unscheduled emergency meeting because of signs that the economy was slipping into a recession. The last half-point cut in the federal funds rate came in November 2002.

Economists said that the Fed’s move today was similarly pre-emptive. “Monetary policy makers are worried about growth being seriously compromised and are prepared to take whatever prudent steps they can to avoid a deep slump,” said Joshua Shapiro, chief United States economist for MFR.

Some aspects of today’s Fed’s move could fuel inflation fears. Gold, a traditional investment safe haven in times of inflation, soared immediately after the Fed’s decision was announced. As United States interest rates became less attractive for investment, the value of the dollar against the euro touched a new low before recovering slightly, and oil prices continued to climb even further above $80 a barrel.

In the stock market, financial stocks posted the biggest gains, reflecting the fact that banks now will face lower borrowing costs, which should help drive profits higher, nytimes.com reports.

Inflation concerns eased slightly as wholesale prices fell by the most in a year, as the Federal Reserve met to consider interest rate cuts.

Prices paid to producers fell more than expected, with a drop of 1.4 per cent compared to a decline of 0.6 per cent the previous month, the Labor Department said.

But core producer prices, which exclude fuel and food costs, rose 0.2 per cent, after a 0.1 per cent gain the month before, ft.com reports.

The jump in rate futures fully priced another rate cut from the Federal Open Market Committee in October, to 4.50 percent, although gains were quickly pared back to show about a two in three chance of another cut next month, Reuters reports.

"It's clear the Fed wants to avoid recession," said Alan Skrainka, chief market strategist at Edward Jones in St. Louis. "The long-awaited, much anticipated start of an easing cycle has begun."

Source: agencies