Fed Cuts Rates 1/2 Point
By John M. Berry
Washington Post Staff Writer
Wednesday, January 31, 2001
The Federal Reserve this afternoon cut its target for overnight interest rates by a half-percentage point for the second time in less than a month in an effort to bolster business and consumer confidence and keep the U.S. economy out of recession.
In addition, the language of the Fed's announcement indicated the central bank will continue to cut rates, perhaps even before the next scheduled policymaking session March 20, if the economy shows signs of continuing to deteriorate. The Fed's top policymaking group, the Federal Open Market Committee, said it concluded that "the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."
Earlier in the day the Commerce Department reported that U.S. economic growth slowed to a crawl late last year. Many forecasters said it isn't expected to do any better in the first three months of this year – and it easily could do worse.
Commerce estimated that growth dipped to a 1.4 percent annual rate in the fourth quarter, the worst for any quarter since the spring of 1995, the last time the American economy flirted with a recession. Growth had begun to slip in the third quarter when the inflation-adjusted gross domestic product increased at only a 2.2 percent rate, down sharply from a 5.6 percent rate in the spring.
Underscoring just how strong growth had been before the second half slowdown, the economy grew by a full 5 percent in 2000, the best annual gain since a 7.3 percent increase in 1984.
The FOMC lowered its target for the federal funds rate, the interest rate financial institutions charge each other on overnight loans, by a half-percentage point to 5.5 percent. The committee also had unexpectedly cut the target by the same amount on Jan. 3, a move that helped generate a stock market rally and improved conditions in U.S. credit markets substantially.
In a related action, the Fed Board reduced the discount rate, the interest rate charged by regional Federal Reserve banks when they lend money directly to financial institutions, by half a point, to 5 percent.
As usual, major commercial banks also began reducing their prime lending rate by the same half point, to 8.5 percent from 9 percent. That will reduce the cost of borrowing for consumers and small businesses. Rates charged on many consumer loans, such as home equity loans and unpaid credit card balances, and most small business loans are tied directly to the prime rate.
The impact on home mortgage rates is less certain. Adjustable rate mortgage rates are likely to fall, but rates on 30-year, fixed-rate mortgages have already come down sharply in recent months in line with yields on 10-year U.S. Treasury notes. Currently those 30-year rates are about 7.15 percent.
The FOMC announcement was unusually detailed in its explanation of why the Fed acted to cut its interest rate target by a full percentage point in less than a month, the first time that has happened since Alan Greenspan became chairman in August 1987.
"Consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins," the announcement said. "Partly as a consequence, retail sales and business spending on capital equipment have weakened appreciably. In response, manufacturing production has been cut back sharply" as firms try quickly to get rid of their stocks of unsold goods.
Against that background, "and with inflation contained, these circumstances have called for a rapid and forceful response of monetary policy. The longer-term advances in technology and accompanying gains in productivity, however, exhibit few signs of abating and these gains, along with the lower interest rates, should support growth of the economy over time," the announcement said.
In congressional testimony last week, Greenspan accurately predicted that fourth-quarter growth was "slightly positive" and added that he believes it is "probably close to zero at the moment."
As the FOMC announcement indicated, the GDP report showed that the weaker growth in the second half of 2000 was concentrated in the manufacturing portion of the economy as inventories mounted and production was cut back to get rid of them. Over the course of the year, nearly 180,000 factory workers were laid off, many of them in the automobile industry.
With demand for autos, trucks and many other types of manufactured goods falling, firms also began to trim their investment plans. In the fourth quarter business spending on new plants and equipment declined for the first time since the 1990-91 recession. Investment in computers and software was still going up, but at a much slower rate than anytime in the last several years. The sharpest drop was in purchases of medium and large trucks, the department said.
"The GDP numbers show a two-tier economy, with the manufacturing sector in recession and industrial production still declining, but the rest of the economy holding up reasonably well," said Jerry Jasinowski, an economist who is president of the National Association of Manufacturers. The confirming news about very slow growth in the fourth quarter "sets the stage for the Fed to cut interest rates significantly later today," he said.
Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York, said his firm expects the economy to grow in the current quarter at about the same very slow pace as the fourth quarter, and to pick up to about a 2 percent rate in the spring. If that turns out to be correct, GDP will have grown only 2 percent or less in the 12 months ending in June, which would be the economy's weakest performance since the recession a decade ago.
"But we don't believe a recession is underway and we expect growth to rebound during the second half of 2001," Steinberg said. The greatest risk to the forecast, he added, is that business investment spending could continue to decline.
Consumer spending, while much less exuberant than in recent years, held up better late last year than many analysts had expected. Purchases of durable goods did fall during the quarter as sales of new cars and light trucks plunged, but spending for non-durable goods and services both increased. Overall, personal consumption spending rose at a 2.9 percent rate, down from a 4.5 percent rate in the third quarter.
Greenspan and many forecasters have expressed worry that consumers, concerned about their job prospects, high energy costs, weak stock prices and other matters, could begin to reduce their spending. Consumer confidence indexes have declined sharply in recent months, but so far spending is still increasing. Indeed, after a poor Christmas selling season, many retailers have seen an unexpected pickup this month.
In another spot of strength, Commerce also said that sales of new homes jumped 13.4 percent in December to an annual rate of 975,000, the second highest monthly rate ever. Sales for all of last year reached 898,000, down only slightly from the 1999 record total of 907,000.
Analysts said there is still strong demand for new homes, particularly since mortgage interest rates have been falling for some time. The lower rates have also spurred a new wave of refinancing of existing mortgages by homeowners, a process that not only lowers monthly payments but often leaves consumers with a chunk of cash they can use to pay off other debts or finance other spending, such as car purchases and vacations.
© 2001 The Washington Post
Best Regards, J.T. |
