Fed cuts rates by half point; dismisses risk of inflation

Washington, May 16: THE Federal Reserve approved its fifth big interest-rate cut in as many months and did nothing to signal that it is ending its dramatic campaign to jump-start the stalled economy. In addition to lowering short-term rates by half a percentage point, the central bank issued a statement dismissing bond market worries that inflationary risks are rising and flatly declared that Fed officials still feel that recession remains the greater danger to the US and the world.

In their surprisingly gloomy assessment of current conditions, chairman Alan Greenspan and his colleagues even seemed to play down some tentative signs that economic activity may be stabilising. Their five-paragraph statement, issued to explain the decision and signal the outlook for future action, was virtually identical to the one given after the emergency rate cut made in April between regularly scheduled meetings.

The rate cut was widely anticipated, and stock markets had little reaction to the 2:15 pm announcement. By day’s end, the major indexes were almost flat, with the Dow Jones Industrial Average down just over four points, and the Nasdaq Composite Index up just under four points.

But the announcement did change expectations for imminent Fed behaviour.

The futures market that trades on coming meetings now expects a better-than-even chance of another rate cut—albeit a smaller, quarter-point one—when officials gather next on June 26 and June 27. Tuesday morning, traders had been betting that Tuesday’s rate cut would be the Fed’s last. “An improvement in the economy over the next several weeks or the passage of aggressive tax cuts could alter this view, but at this point, odds favour more stimulus from the Fed,” said Michael Moran, chief economist of Daiwa Securities America Inc.

The central bank’s target for the fed-funds rate—the rate banks use to lend to each other overnight—is now at 4 per cent, the lowest level in seven years and nearly 40 per cent below the 6.5 per cent level in place for much of last year.

The Fed also lowered the largely symbolic discount rate it charges on loans to banks to 3.5 per cent from 4 per cent. Such loans are rarely made in practice. The effects will ripple quickly through interest-sensitive sectors of the economy. Within minutes of the Fed’s announcement, major commercial banks— such as Bank of America Corp and Bank One Corp—announced a parallel reduction in their prime rate to 7 per cent from 7.5 per cent.

-- The Wall Street Journal