Washington, Nov. 7 (Reuters): The US Federal Reserve on Wednesday slashed interest rates by a sharp half percentage point to new four-decade lows to try to re-ignite the recovery, but signalled it planned no more cuts any time soon.
The large drop in borrowing costs startled financial markets expecting a more modest cut. The central bank’s policymakers delivered a second surprise by indicating they are likely to stand pat after the latest reduction, saying economic risks were balanced between weakness and inflation. The latest action should be enough to help the economy through its “soft spot,” they said.
The bank’s Federal Open Market Committee voted unanimously to drop the trendsetting federal funds rate that banks charge each other for overnight loans to 1.25 per cent. It was the first rate cut this year after 11 reductions in 2001.
The Fed also lowered the more symbolic discount rate it charges for emergency loans to banks by a matching amount to a new record low of 0.75 per cent.
Fortunes have soured quickly for the US economy, with recent data indicating that manufacturing is stalling and a slide in jobs for the past two months.
According to the measure of inflation Fed chairman Alan Greenspan favours, real interest rates are now below zero. Some analysts have warned this means the Fed is nearly out of manoeuvring room and that deflation, or a widespread decline in prices, poses a bigger potential threat than inflation.
But the Fed, faced with a wobbling recovery and at least a possibility of deflation if consumers rein in spending, has little choice except to fire its policy bullets and hope it creates a more buoyant mood throughout the economy.
“This move could...backfire by announcing to the world that the economy is so weak that Chairman Greenspan has to use what little ammunition he has left to shore up the economy,” warned economist Sung Won Sohn of Wells Fargo Bank in Minneapolis.
Steady rates anticipated
A poll by Reuters of primary dealers—big Wall Street firms that deal directly with the Fed—after the Fed decision found 13 out of 20 expected the central bank to keep rates steady through mid-2003. They were unanimous in expecting steady rates through the end of the year.
Most financial market participants had expected a more modest quarter-point cut and for the Fed to retain its warning that further weakness was the greatest economic threat.