Tuesday, December 11, 2007

Fed Lowers Rate by a Quarter Point to 4.25 Percent (Update6)

By Craig Torres

Dec. 11 (Bloomberg) -- The Federal Reserve lowered its benchmark interest rate by a quarter point to 4.25 percent, while signaling officials are open to further cuts if the housing slump and credit squeeze worsen.

Stocks fell and Treasury notes surged after the decision, which some economists said fell short of what's needed to spur lending and avert a recession. The central bank also pared the discount rate by a quarter point to 4.75 percent, counter to speculation among investors that the Fed would make a deeper reduction.

``Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,'' the Federal Open Market Committee said in a statement after meeting today in Washington. Lower borrowing costs ```should help promote moderate growth over time.''

The Fed dropped language from its previous statement that risks of slower growth and faster inflation were ``roughly'' balanced. The economy is faltering after a third-quarter surge as house prices drop, consumer spending slows and banks tighten lending standards for even their best customers.

Policy makers are actively considering steps to ease credit in financial markets, and haven't ruled out moves to increase liquidity before their next scheduled meeting on Jan. 29-30.

``If things deteriorate they will cut again,'' said Stephen Cecchetti, professor of international economics at Brandeis University in Waltham, Massachusetts, and a former director of research at the New York Fed. ``If financial conditions don't start to improve dramatically,'' officials might have to cut before their January gathering, he said.

Discount Rate

The gap between the discount rate, which the Fed charges for direct loans, and the federal funds rate, the rate banks charge each other for overnight loans, remains half a point.

``Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending,'' the FOMC said. ``The committee will continue to assess the effects of financial and other developments in economic prospects and will act as needed to foster price stability and sustainable economic growth.''

The central bank also said some ``inflation risks remain,'' and probably was reluctant to reduce borrowing costs at all, said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs and now a resident scholar at the American Enterprise Institute in Washington.

Rosengren Rebels

Today's decision, which matches the median forecast of economists surveyed by Bloomberg News, wasn't unanimous. Boston Fed President Eric Rosengren voted in favor of a half point cut.

Rosengren has a background in banking, having formerly headed the Boston Fed's banking supervision department. His research focused on financial crises including New England's credit crunch in the early 1990s and Japan's bad-loan debacle last decade.

The Dow Jones Industrial Average slumped 2.1 percent to 13,432.77, while the yield on the two-year Treasury note --among securities most sensitive to official interest rates --declined about 25 basis points to 2.92 percent at 4:33 p.m. in New York.

``When stocks go into a tailspin after you release your press statement, you know as a central banker that you didn't meet the market's expectations,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``There were rumors today about the possibility of 50 basis points, so that was a modest disappointment.''

Policy Under Bernanke

The benchmark rate is now at the lowest level since January 2006. Bernanke, 53, who succeeded Alan Greenspan as chairman the following month, continued a series of increases that lifted the federal funds rate to 5.25 percent by June last year.

Policy makers held their ground until August this year, when the collapse in assets backed by subprime mortgages roiled markets around the world and forced central banks to pump billions of dollars into the banking system. It also spurred the Fed to start cutting the federal funds rate in September. The Fed was joined last week by the Bank of Canada and Bank of England.

Investors became confident of further reductions after Bernanke and Vice Chairman Donald Kohn said in separate speeches last month that ``turbulence'' in markets could alter their outlook for growth. Fed officials estimated in October the economy would grow 1.8 percent to 2.5 percent in 2008. Rosengren said Dec. 3 that the expansion will be ``well below'' its long- term pace for the next two quarters.

Weaker Numbers

Since Fed officials made their forecasts, government reports show orders for U.S.-made durable goods fell in October, capacity-use rates in the nation's factories slipped and retail sales slowed. Payrolls increased by 94,000 jobs last month, after a 170,000 increase in October.

The economy will expand at an annual pace of 1 percent in the fourth quarter, down from 4.9 percent in the previous three months, according to the median estimate in a Bloomberg News survey of 63 economists.

The number of Americans who fell behind on their mortgage payments rose to a seasonally adjusted 5.6 percent in the third quarter, the highest in two decades, the Mortgage Bankers Association said last week. New foreclosures hit a record.

As creditors took possession of properties, the supply of unsold homes grew to a 10.8-month supply in October. Prices of previously owned homes fell 5.1 percent from a year ago, the most on record, according to the National Association of Realtors.

Across Atlantic

The credit deterioration has spread to Wall Street and commercial banks around the world that hold bonds and derivative contracts created from pools of home loans. Banks including Credit Suisse Group in Zurich and London-based Barclays Plc are among lenders that have marked down more than $50 billion on losses linked to U.S. home loans.

Because banks are protecting capital, lending has been cut and concerns about counter-party risk are higher. About 40 percent of lenders have increased their standards for the most creditworthy borrowers to qualify for a so-called prime loan, according to a Fed study in October.

Throughout the rate cutting-cycle, Fed officials have highlighted longer-term inflation risks in their statements and their public remarks. Oil prices hit a record $99.29 a barrel in New York on Nov. 21, and traded at $89.21 this morning.

The Fed's preferred gauge, the personal consumption expenditures price index excluding food and energy, rose 1.9 percent in October from a year ago. The index has remained below 2 percent since June.

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