Fed Lowers Rate to 4.75 Percent, First Cut Since 2003 (Update6)

By Scott Lanman and Craig Torres

Sept. 18 (Bloomberg) -- The Federal Reserve lowered its benchmark interest rate by a half point to 4.75 percent, the first cut in four years, to protect the U.S. from sinking into a recession sparked by fallout from the housing-market collapse.

``Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets,'' the Federal Open Market Committee said in a statement after meeting today in Washington. The central bank will ``act as needed to foster price stability and sustainable economic growth.''

Stocks surged, two-year Treasury notes rose and the dollar fell to a record low against the euro. The larger-than-forecast reduction suggests Chairman Ben S. Bernanke is prepared to leave himself open to criticism that he's rescuing investors from bad decisions for the sake of saving the six-year expansion.

``You forget about everything else, and you have to make sure the worst-case doesn't happen,'' said Stephen Cecchetti, a former New York Fed research director who is now a professor at Brandeis University in Waltham, Massachusetts. ``This is very forward-looking.''

Core inflation has improved ``modestly'' this year, while some risks remain, the Fed said. The decision was unanimous.

``Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction, and to restrain economic growth more generally,'' the FOMC said.

Adhering to Schedule

The decision is also a sign that policy makers don't want to cut rates between their regular meetings, Cecchetti said. Policy makers next gather Oct. 30-31. Traders repeatedly speculated on an unscheduled rate announcement in the past month.

The federal funds rate, which banks charge each other for loans, had stood at 5.25 percent since June 2006. That's when the Fed ended a two-year run of increases that lifted the rate from a four-decade low of 1 percent.

Most economists anticipated a quarter-point, and traders had pared bets on a bigger move in recent days as some Fed officials signaled they would be reluctant to back a half-point cut.

``Clearly they are trying to be preemptive,'' said Paul Kasriel, chief economist at Northern Trust Co. in Chicago and a former Fed economist. At the same time, the inflation language suggests that officials are ``trying to increase their options at upcoming meetings,'' he said.

Discount Rate

The Fed's Board of Governors also lowered the rate on direct loans to banks by half a percentage point to 5.25 percent.

The Fed first reduced the so-called discount rate by a half point on Aug. 17 in a surprise move to restore confidence after some companies found it hard to obtain funds as investors fled riskier assets. The credit crunch was caused by losses in securities tied to subprime mortgages.

It was the first time in almost five years that the Fed move differed from analysts' predictions. The half-point reduction in the federal funds target was forecast by 23 of 134 economists surveyed by Bloomberg News. One hundred and five predicted a reduction of 25 basis points, while six forecast no change. A basis point is one-hundredth of a percentage point.

The Standard & Poor's 500 Index climbed 2.9 percent, the biggest gain since March 2003. The Fed last cut the federal funds target in June 2003, to 1 percent from 1.25 percent. Meantime, crude oil climbed to a record and gold and copper surged.

Traders expect the Fed to reduce the benchmark rate to 4.25 percent by the end of 2007, compared with a forecast of 4.5 percent yesterday, based on futures prices.

Protecting Lenders

Today's move suggests Bernanke's comment on Aug. 31 that it's not the Fed's responsibility ``to protect lenders and investors from the consequences of their financial decisions'' may be little more than talk for now, said Neal Soss, chief economist at Credit Suisse in New York.

``This concern about moral hazard is a whole lot easier to preach than it is to implement,'' said Soss. ``It's very hard to administer tough love.''

Investors began anticipating a reduction on Aug. 9, a week before the Fed made the initial discount-rate cut and said risks to growth have ``increased appreciably.'' Two weeks later, Bernanke said in a speech that the central bank would ``act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.''

Shifting Focus

Policy makers were forced to shift their focus to growth from inflation in August as rising defaults on subprime mortgages rippled through global credit markets. Asset-backed commercial paper contracted by the most in at least seven years and Countrywide Financial Corp., the biggest U.S. mortgage company, was shut out of the market.

The decision comes two days before Bernanke faces lawmakers in a House Financial Services Committee hearing on the mortgage- market crisis. Representative Barney Frank, the Massachusetts Democrat who heads the panel, on Sept. 7 called for a ``meaningful'' rate cut by the Fed.

Today, Frank said he was ``pleased'' with the rate reduction yet ``surprised'' that, in his judgment, the Fed's ``continued concern about inflationary risk outweighs what I believe to be growing risks to sustained growth.''

Separately, House Speaker Nancy Pelosi said the Fed move ``underscores the economic insecurity that middle-class Americans have long been feeling.'' The California Democrat said in a statement that she hopes the rate cut ``will bring some relief to the middle class.''

Economic reports show that the deepening recession in housing is taking a toll on the broader economy. The Labor Department said Sept. 7 that employers cut 4,000 workers in August. Job growth has been slowing since June, Atlanta Fed President Dennis Lockhart acknowledged. August figures for retail sales and industrial production were below economists' forecasts.

Highlighting Risks

Officials including Fed Governor Frederic Mishkin and San Francisco Fed President Janet Yellen highlighted the risks to spending in speeches this month. Teams of Fed economists also ran what-if scenarios to supplement the central forecast given to the FOMC members today.

Inflation has also receded. The Fed's preferred price gauge, which excludes food and energy costs, rose 1.9 percent from a year earlier in July, within the 1 percent to 2 percent comfort range stated by several officials. The Labor Department said today that producer prices fell 1.4 percent in August, more than economists predicted.

Policy makers including Philadelphia Fed President Charles Plosser and Richard Fisher of the Dallas Fed signaled they were less likely to support a half-point cut this month. Plosser said Sept. 8 that he had not made up his mind on rates. Neither has a vote on the FOMC this year.

``Lowering the funds rate overall doesn't boost housing,'' said Lee Hoskins, a former Cleveland Fed president and now senior fellow at the Pacific Research Institute in San Francisco. ``All this does is delay the day in which these wealth losses will finally be worked out in the marketplace, so I don't regard this as a particularly good move.''

Last Updated: September 18, 2007 17:31 EDT