Fed trims key rate half-point

Surprise action boosts stock prices, hopes of investors

`Almost a panic move'

Between meetings, cut signals worry economy will falter

January 04, 2001|By William Patalon III | William Patalon III,SUN STAFF

Faced with high energy prices, a rapidly slowing economy and spiraling recession worries, Federal Reserve policymakers slashed a key interest rate by half a percentage point yesterday, a surprise move that ignited record stock gains and stoked expectations that more rate cuts will follow.

The size and timing of the rate reduction - four weeks before the next scheduled meeting of the central bank's Federal Open Market Committee, when such decisions are typically made - tells many economists that Fed Chairman Alan Greenspan thinks the economy is slowing far too quickly.

"This almost indicates a panic move on the part of the Fed," said Robert T. Sweet, chief economist for Allied Investment Advisors in Baltimore. "It makes me think they are worried. That's the important thing to note - they're doing it between meetings."

The central bank boosted rates six times between June 1999 and May last year, hoping to engineer a so-called "soft landing" for an economy in which galloping growth was threatening to unleash rampant inflation.

Those increases came a quarter-point at a time, except for the last one in May, a half-point bump.

What the FOMC did was to cut the overnight lending rate - what Fed member banks charge one another for overnight loans - by a half-point to 6 percent. The Fed Board of Governors also voted to cut the more symbolic discount rate by a quarter-point to 5.75 percent and said it stands ready to reduce it by another quarter-point.

Cutting interest rates makes it cheaper to get money for spending, or for starting or expanding businesses.

"These actions were taken in light of further weakening of sales and production, and in the context of lower consumer confidence, tight conditions in some segments of the financial markets, and high energy prices sapping household and business purchasing power," the Fed said in a statement.

The last time Fed policy-makers cut interest rates between meetings was in October 1998, when the Asian economic crisis was threatening to sink the U.S. economy.

Stocks soared in response yesterday. Within 15 minutes of the Fed's announcement a little after 1 p.m., the Dow Jones industrial average spiked more than 380 points.

The Dow finished up 299.60 points, or 2.8 percent, closing at 10,945.75. The technology-heavy Nasdaq composite index had its biggest day ever, jumping 324.83 points, or 14.17 percent, to finish at 2,616.69.

Both the points and percentage gains were the biggest one-day increases ever for the Nasdaq, and the 3.12 billion shares that changed hands marked its heaviest trading day ever.

It was also the first time more than 3 billion shares were traded. Even so, the Nasdaq remains 48 percent below its March 10 closing high of 5,048.62.

The central bank said it had room to cut rates because "inflation pressures remain contained."

Many economists had hoped to see the rate reductions a bit earlier. On Dec. 19, when the FOMC last met, the committee voted to keep rates where they were, but cited the risk of further economic weakness in saying that it would "continue to monitor closely the evolving economic situation."

Some economists are anticipating additional rate reductions soon, perhaps at the Jan. 30-31 meeting. That's because evidence of a greater-than-desired slowdown has been gathering.

This week, an index of factory activity showed that U.S. manufacturing in December slumped to its lowest level since the end of the 1990-1991 recession. The National Association of Purchasing Management's factory index - one of the indicators watched by Greenspan - fell to 43.7 last month from 47.7 in November, the fifth straight monthly decline and the 10th drop in 12 months. Readings below 50 signal a contraction.

Gross Domestic Product, which rose at a 5.6 percent annual rate in the second quarter of 2000, grew by 2.2 percent in the third quarter, the slowest pace in four years. Fourth-quarter GDP should rise at 2.7 percent, according to the consensus estimate of analysts surveyed by Bloomberg News.

Consumer confidence, which remained at all-time highs for much of the past year, has dropped to its lowest point in two years as stock prices nose-dived and energy prices gnawed at workers' wages.

How consumers feel is key because consumer spending accounts for about two-thirds of all activity in the $10 trillion U.S. economy: A slump in confidence translates into a slump in spending, which in turn hurts the American economy - a scenario that appears to have manifested itself during a Christmas shopping season that wasn't what many retailers had hoped for.

Retail sales fell in November, the first monthly decline in seven months. Sales figures for December are slated for release today.

Without the Fed stepping in to reduce rates, the probability of a recession this year might have been as high as 40 percent, said David Orr, chief economist for First Union in Charlotte, N.C.

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