Fed trims rates again

Policymakers cut overnight lending interest by half-point

4% is lowest in 7 years

Move was expected

soft economy could spark repeat in June

May 16, 2001|By William Patalon III | William Patalon III,SUN STAFF

In a move that was widely anticipated, Federal Reserve policy-makers cut the key federal funds rate yesterday by a half-percentage point to 4 percent - its lowest level in seven years - and hinted that the economy's weakness made still another reduction possible.

"It was pretty much in line with expectations," said David Straus, senior portfolio manager with Washington, D.C.-based Johnston Lemon Asset Management Inc.

It was the fifth time this year that the central bank's policy-making Federal Open Market Committee has slashed short-term interest rates by half a percentage point, a newfound aggressiveness that most likely has the Fed near the end of its current rate-cutting campaign, many economists said.

Expectations are for a final reduction - a quarter-point or a half-point - after the FOMC's next meeting late next month.

The federal funds rate, also known as the overnight lending rate, is what Fed member banks charge one another for overnight loans; it guides short-term interest rates in the marketplace.

The central bank also cut the more symbolic discount rate by a half-point, to 3.5 percent, yesterday.

Banks immediately announced reductions in their prime lending rates - those they charge their best customers.

Bank of America Corp., Bank One Corp., SunTrust Corp. and First Union Corp. were among the major banks that said their prime rate would drop from 7.5 percent to 7 percent, effective today.

U.S. consumers who hold credit cards also should benefit from yesterday's Fed action, saving at least $1.2 billion over the next 12 months, according to CardWeb .com, the Frederick-based firm that tracks the credit card industry.

Stock market reaction was mild but mixed yesterday, as a rally fizzled, in part because the rate cuts were expected.

The Dow Jones industrial average fell 4.36 points, or 0.04 percent, to close at 10,872.97. The Nasdaq composite index rose 3.66 points, or 0.18 percent, to finish the day at 2,085.58.

In the statement that accompanied the rate reduction announcement, the Fed noted that both consumer spending and housing remain strong and that businesses have worked off a lot of the excess inventories that posed a problem earlier this year.

But capital investment by companies continues to drop, and a poor outlook for corporate profits doesn't figure to help. Weak stock prices could weigh on consumers, the central bank said.

Overall, "the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," said the Federal Reserve, hinting that yet another rate cut loomed.

Economists had different reactions to the statement.

The rate cut was "exactly what I expected, and the [accompanying] language was exactly what I expected," said Neal Soss, chief economist for Credit Suisse First Boston in New York City.

"There's no hint that they're considering an end to the current easing cycle. That's appropriate: They don't want to convey that to the markets, and furnish a bearish attitude."

Even with that caution in its language, however, Soss believes the Fed is done cutting rates but merely wants the economic news to improve before it actually says so.

Others disagreed.

David A. Citron, a managing director in the Pikesville office of money manager Carret and Co., thinks the Fed will lower rates again - by as much as a half-point - after its June meeting.

"Unfortunately, I think Greenspan got a little behind the curve," Citron said, citing the dismal news about the U.S. industrial sector that came out Monday.

"I think he found himself caught behind the eight ball. ... I think he needs to lower again."

It's the mixed messages the economy is sending out that make it so difficult for analysts to predict what will happen next.

While the consumer spending numbers were unexpectedly strong last week, this week's industrial production report said that indicator had fallen for the seventh straight month, the worst showing since 1982.

And worker productivity, an area where large gains have supported the economy's historically fast growth rates, declined in the first quarter for the first time in six years.

The telecommunications sector is a particularly bothersome part of the economy. The explosive growth of the Internet fueled tremendous investments in high-speed networks, many of which now are barely being used.

Reduced interest rates won't fix that problem - only time will, as demand increases and the networks get used, many economists say.

The telecom sector was one of the major drivers of the 1998-2000 boom; for now, however, corporate profits have plunged and aren't expected to improve anytime soon.

Richard Yamarone, chief economist for Argus Research Co. in New York City, said the jobs report that comes out early next month will be the factor that most influences the Fed's next move.

If the economy continues to shed jobs, the central bank will cut rates again - even if that means going too far, as many believe it did when it raised rates from the second half of 1999 into the first part of 2000.

But the central bank wants to calm fears now, even if it has to raise rates later, he said.

"The Fed could very easily overdo it," Yamarone said.

Wire services contributed to this article.

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