U.S. Federal Reserve Cuts Overnight Bank Lending Rate 1/4 Point to 5.25%
U.S. Fed Cuts Overnight Lending Rate By Quarter Point to 5.25%
Washington, Sept. 29 (Bloomberg) -- The Federal Reserve cut U.S. interest rates for the first time in almost three years, a move aimed at easing the effects of a global slowdown on the U.S. economy.
The Federal Open Market Committee, the Fed's policy-setting arm, cut the target federal funds rate on overnight loans between banks by a quarter point to 5.25 percent. It was the first interest rate cut since Jan. 31, 1996, and should lead to lower borrowing costs for everything from auto loans to home mortgages to working capital loans for businesses. ''The action was taken to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies and of less accommodative financial conditions domestically,'' according to a statement issued by the FOMC. ''The recent changes in the global economy and adjustments in U.S. financial markets mean that a slightly lower federal funds rate should now be consistent with keeping inflation low and sustaining economic growth going forward,'' the Fed said.
At the same time, the Fed Board of Governors left the discount rate for loans to banks from the Fed system unchanged at 5.0 percent, where it's been since January 1996.
The Fed's move was an attempt to send a signal to the world -- rather than intended to boost an economy that's already enjoying the lowest unemployment rate in a generation and the near-absence of inflation. There no sign, though, that the Fed's action will be followed by a similar rate cut by Germany or other industrialized countries to further increase global demand.
Japan, South Korea, Thailand, and Indonesia are in recession. Russia devalued its currency and defaulted on its debt. And as concerns mounted that Brazil might devalue its currency, the Federal Reserve Bank of New York brokered an unprecedented $3.6 billion rescue to prevent hedge fund Long-Term Capital Management LP from collapsing.
Greenspan Warning
That combination caused Fed Chairman Alan Greenspan to warn Congress last week that the flow of funds through financial markets has been disrupted -- a signal of the Fed's anxiety that a credit crunch could sweep markets worldwide. ''Deteriorating foreign economies and their spillover to domestic markets have increased the possibility that the slowdown in the growth of the American economy will be more than sufficient to hold inflation in check,'' Greenspan told the Senate Budget Committee.
Some analysts expect more interest-rate cuts. ''Greenspan will ease several times,'' said Jason Trennert, an economist at ISI Group in New York. ''Much as they used preemptive hikes to prevent inflation, they'll use preemptive easings to prevent serious economic dislocations.'' Fed policymakers have two more meetings this year, on Nov. 17 and Dec. 22.
Before today's action, the fed funds rate was higher than the yield on every U.S. Treasury security from three-month bills to 30-year bonds. And on an inflation-adjusted basis, the central bank's key rate was one of the highest among industrialized countries.
Fraying Margins
The clearest signs of what Greenspan recently called ''fraying at the margins'' of the U.S. economy are in manufacturing and trade.
The National Association of Purchasing Management's factory index has declined in four of the last five months -- and is expected to fall again in September. That's a sign U.S. manufacturing is contracting -- driven in part by falling exports. ''Cash-strapped overseas customers continued to slash orders for U.S. exports, attitudes toward any meaningful inventory accumulation remain quite defensive, and the Fed's Beige Book made specific mention of the continued problems in manufacturing,'' said Patrick Dimick, an economist at Warburg Dillon Read in Stamford, Connecticut.
For example, Gillette Co., the world's biggest maker of razor blades, said Monday it will dismiss 11 percent of its workforce and close 14 factories over the next year and half to cut costs in wake of slumping sales.
And Goodyear Tire & Rubber Co., North America's largest tiremaker, said it will make less money than analysts expected in the third quarter because of declining sales amid economic turmoil in Asia and Latin America. The Akron, Ohio-based company boosted the number of planned jobs cuts to 800 from the 600 it announced in August.
Confidence Falling
Moreover, the Conference Board reported today that U.S. consumer confidence fell this month to the lowest level in almost a year -- a sign falling stock prices, the threat of impeachment hanging over President Bill Clinton and recessions overseas could trigger a decline in domestic spending.
The confidence index declined more than expected to 126.0 in September from August's 133.1, the Conference Board said. The index hasn't been this low since last October.
A separate Conference Board index gauging consumer expectations for the next six months fell to 95.9 in September from 106.8 in August. September's reading was the weakest since it was 93.5 in November 1996, according to Bloomberg analytics. 'People Are Nervous' ''The economy is still doing well, but people are nervous about the markets,'' said Gary Thayer, an economist at A.G. Edwards & Sons Inc. in St. Louis, who likened the environment to the aftermath of the 1987 stock market crash. ''The underling fundamentals -- unemployment, the interest rates people are paying -- are still favorable,'' he said.
The virtual absence of inflationary pressures in the U.S. allowed the Fed to take today's action. In the first eight months of 1998, consumer prices rose at an annual rate of 1.6 percent, the same increase as the first eight months of 1997. Inflation has stayed benign as weakening economies in Asia depressed commodity prices and the cost of imported goods.
Banks are likely to cut their prime rates, those charged to their best customers and a yardstick against which other consumer and corporate loans are measured. The prime rate, which is 8.5 percent at most banks, should fall by at least a quarter point.
Prime Rate Cuts
Some banks already acted in anticipation of the Fed's action. Last week, Southwest Bancorp of St. Louis, the operating unit of Mississippi Valley Bancshares Inc., cut its prime rate by half a point to 8 percent. Earlier today, Union Center National Bank of Union, New Jersey, did likewise.
Banks will also probably cut the interest rates they pay on savings accounts and certificates of deposit.
Fed policymakers had kept the overnight bank rate at 5.50 percent since March 25, 1997, when they raised it by a quarter percentage point, citing ''persisting strength in demand, which is progressively increasing the risk of inflationary imbalances.''
When the FOMC last cut the overnight rate by a quarter point in January 1996, central bankers cited a lack of inflationary pressures and the need to keep the economy growing.
This time, Greenspan could only cite some ''erosion'' of the economy in his recent congressional testimony. After all, average incomes rose 5.1 percent over the 12 months ending in August, just below the 5.6 percent annual gain averaged over the last three years. Unemployment and mortgage rates are at or close to their lowest points in a generation.
High Spending Rate
With money in their pockets, consumers spent at a 6.1 percent annual rate in the second quarter, matching the robust 6.1 percent gain in the first three months of the year. The last time spending was higher than that over a six-month period was in the third and fourth quarters of 1983, when spending rose by an average 6.2 percent annual rate. ''We probably are passing through the optimal combination of rapid growth and low inflation,'' said Lynn Reaser, chief economist at NationsBank Private Client Group in Jacksonville, Florida.
Few analysts were surprised by today's Fed action. A Bloomberg News survey of economists at the 32 banks and securities firms that deal directly with the Fed's trading desk found that 30 expected an interest-rate cut this week, though there was division about how big of a cut in interest rates there'd be.
Nikko Securities Co. expected no change in rates and Citicorp analysts declined to make a forecast, citing the pending merger with Travelers Group Inc., the parent company of Salomon Smith Barney Inc.
Greenspan began dropping hints about the need for lower interest rates earlier this month, reversing the position he took in testimony to Congress in late July that higher borrowing costs might be needed to cool an economy showing few signs of slowing.
His warning last week to Congress about the potential of a ''spillover'' from global woes to the U.S. economy was just the latest in a series of cautions. ''It's just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress,'' Greenspan said earlier this month at the University of California at Berkeley.
Lower Growth Seen
Greenspan didn't specify just how much he expects the U.S. economy to slow. New York Fed Bank President William McDonough did, however. McDonough told reporters in Vienna last week that he expected the U.S. economy to grow at an annual rate of 2 percent to 2.5 percent in the second half of the year before slowing further in 1999. That's well below the 3.7 percent annual growth rate in the first half of this year.
The voting members of the FOMC include six Fed governors plus the president of the Federal Reserve Bank of New York and the presidents of four of the other 11 regional Fed banks, who rotate service annually. The other regional bank presidents participate in FOMC discussions without voting on interest rates.
When Fed policymakers decide to lower the overnight bank rate, they direct the New York Fed to buy U.S. Treasury securities on the central bank's behalf. Such action influences interest rates by pumping money into the banking system.
By announcing its policy decisions -- a practice since 1994 -- the Fed speeds the response of financial markets. The federal funds overnight rate, which fluctuates daily, moves close to the target almost immediately after an announcement, and banks adjust their prime lending rates a short time later.
Changes in the discount rate, meantime, require a majority vote of Fed governors and must be based on a request from one or more of the Fed's 12 district banks.
bloomberg.com
David
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