Fed Trims Rate to 2%


The Federal Reserve lowered its main interest rate by a quarter of a percentage point to 2 percent, the seventh cut since the onset of a global credit squeeze that's eroded economic growth.

While a nine-month contraction in credit and soaring fuel prices have pushed the economy to the edge of a recession, confidence has begun to return to financial markets. Inflation expectations are also picking up, driven by near record prices for oil and higher food expenses. Stocks pared gains after the decision, while the dollar and Treasury notes were little changed.

Oil prices marched to another record high of $119.93 a barrel on April 28. The Fed said indicators of inflation expectations have risen. ``The committee expects inflation to moderate in coming quarters, reflecting the projected leveling- out of energy and other commodity prices and an easing of pressures on resource utilization,'' the Fed added.

At the same time, the economy is faltering. Hours before the Fed decision, the Commerce Department reported that gross domestic product increased at an annual pace of 0.6 percent last quarter. Spending by households, the biggest part of the economy, grew at the slowest pace since 2001, when the U.S. economy was in a recession.

The Fed Board of Governors also voted to lower the discount rate, the cost of direct loans from the central bank, to 2.25 percent. Officials reduced the normal 1-point spread over the federal funds rate in August to a half point to ease liquidity constraints. They further narrowed the difference on March 16, in the first weekend emergency move since 1979.

Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser dissented from today's decision, preferring no change. They also objected to last month's reduction.

Central bankers have reduced the interbank lending rate 2.25 percentage points in 2008 with a series of aggressive rate actions, including two three-quarter point cuts and one half- point cut prior to today's move. In addition, the Fed resorted to an emergency authority in March and opened a direct loan window for investment banks.

The actions have reduced risk premiums for financial firms, and stock prices have climbed since the previous Fed meeting on March 18.

The Standard & Poor's 500 Index has rallied since Fed officials last met. Yields on five-year obligations of Fannie Mae, the largest U.S. mortgage company, have fallen to 0.56 percentage points over Treasury notes of similar maturity, down from 0.90 percentage point.

The world's biggest financial companies have posted at least $312 billion in writedowns and credit losses tied to U.S. mortgage markets as of April 28. U.S. foreclosure filings more than doubled in the first quarter as payments rose for subprime adjustable mortgages. One in every 194 U.S. households, or 650,000 properties, were in some stage of foreclosure during the quarter, according to Irvine, California-based RealtyTrac Inc., a vendor of data.

While easing borrowing constraints, the central bank has also pushed money market yields below inflation, giving consumers an incentive to spend or take on more risk in their investments to earn a return. The Fed's preferred inflation barometer, the personal consumption expenditures price index, minus food and energy, rose at a 2.2 percent annualized rate in the first quarter. Six-month Treasury bills yield 1.7 percent.

Five-year-ahead inflation expectations measured by the Reuters/University of Michigan survey rose to 3.2 percent April, the highest level since October 2005.

Meanwhile, housing markets are still in a slump. Home prices in 20 U.S. cities fell in February by the most on record. The S&P/Case-Shiller home-price index dropped 12.7 percent from the same month a year earlier, the most since the figures were first published in 2001. Builders broke ground on 947,000 new homes at an annual rate in March, the fewest since March 1991.

 


TradingEconomics.com, Bloomberg
4/30/2008 11:42:39 AM