Fed cuts interest rates by 50 basis points

Fed cuts interest rates by 50 basis points

By Krishna Guha and James Politi in Washington and Michael Mackenzie in New York

Published: January 30 2008 19:15 | Last updated: January 31 2008 00:47

The Federal Reserve on Wednesday cut interest rates by another 50 basis points and signalled that the door was open to further reductions in an aggressive move to combat the risk of a US recession.

The move to cut rates to 3 per cent initially triggered a broad rally in stocks -- the S&P 500 jumped 1.7 per cent in the first 45 minutes after the announcement -- only for the market to turn lower just before the closing bell.

The dollar meanwhile fell to a record low against the euro before closing slightly higher.

The 50 basis point reduction in the Federal Funds rate came hot on the heels of last week’s emergency 75 basis point cut. The combined 125 basis point reduction represents the most abrupt easing of monetary policy by the US central bank since the early 1980s.

The scale of the move reflects chairman Ben Bernanke’s determination to get ahead of the deterioration in the US economy following criticism that the Fed was “behind the curve” on monetary policy.

In addition to offsetting the decline in its base case forecast for the economy, the Fed wants to buy some insurance against the possibility that the worst-case outcome for growth -- a deep and protracted recession -- could materialise.

This represents a reassertion of the Fed’s “risk management” approach to policy. But it also stimulated debate as to whether the Bernanke Fed is starting to move away from the Greenspan-era practice of gradualism -- moving interest rates in a series of small incremental moves.

Earlier, fresh data showed that a sharp reduction in business inventories had cut US growth to 0.6 per cent in the fourth quarter, its lowest growth rate since 2002.

In a statement, the Fed said its actions would “help promote moderate growth over time” and “mitigate the risks to economic activity”. But, it said, “downside risks to growth remain”. The US central bank said it would continue to assess the effects of financial and other developments and “act in a timely manner as needed to address those risks”.

The focus on the downside risks to growth and the pledge to act in a “timely manner” suggest the Fed will consider cutting interest rates again, although it will probably hope not to have to do so before its next scheduled policy meeting in March.

But the Fed signalled that investors should not assume it will carry on cutting rates in 50 or 75 basis point increments by toning down its description of growth risks from the phrase “appreciable downside risks” in its inter-meeting statement.

The 50 basis point cut was approved by a nine to one margin, with Richard Fisher, president of the Dallas Fed, dissenting. The Fed also unanimously approved a 50 basis point cut in the discount rate at which it lends directly to banks. The move came in spite of data that showed that core inflation moved higher in the final quarter of 2007 and indications that the US labour market is not collapsing.

The Fed said “financial markets remain under considerable stress” and “credit has tightened for some businesses and households”. It said recent information indicated a “deepening of the housing contraction” as well as “some softening in labour markets”.

It left its language on inflation unchanged, saying it would “continue to monitor inflation developments carefully”.

The S&P 500 closed down 0.5 per cent at 1,355.81.

The yield on the two-year Treasury note closed down 5 basis points at 2.22 per cent, while the yield on the 10-year note closed up 4 basis points at 3.74 per cent. The dollar was lower by 0.6 per cent at $1.4869 against the euro.