Fed mulls another rate cut

October 28, 2008 2:22:07 PM PDT
Disappearing jobs, burrowing consumers and skittish companies are reasons for the Federal Reserve to ratchet down interest rates and brace the tottering economy. Fed Chairman Ben Bernanke and his colleagues opened a two-day meeting Tuesday afternoon - their last before the November elections - to make a fresh assessment of economic and financial conditions and decide their next move on rates. Their decision - widely expected to be a rate reduction - the second in two weeks - will be announced Wednesday.

Betting on a hefty rate cut, Wall Street staged an energetic rally. The Dow Jones industrials zoomed 889.35 points, its second-largest point gain ever.

Investors and many economists are predicting the Fed will slash its key rate by half percentage point to 1 percent. A few think the Fed will opt for a smaller, quarter-point reduction to 1.25 percent.

"I'm torn," Stuart Hoffman, chief economist at PNC Financial Services Group, said about the size of the cut. "Clearly, the economic outlook has weakened," he said.

Whatever the size of the rate cut, commercial banks' prime lending rate for millions of consumer loans would drop by a corresponding amount. The prime rate is now at 4.5 percent and is used to peg home equity loans, certain credit cards and other floating rate loans.

Under either scenario - a half percentage point or a quarter point cut - both the Fed's key rate and the prime rate would fall to their lowest in more than four years.

In grim news, consumer confidence plunged to its lowest level on record. The Conference Board reported Tuesday that its index dropped to 38 in October, from 61.4 in September. That bunker mentality makes it more likely shoppers will retrench even more, throwing the economy into a tailspin.

Underscoring one of the big stresses Americans are under: the value of homes - people's biggest asset - dropped by record amounts.

The Standard & Poor's/Case-Shiller 20-city housing index released Tuesday showed a drop of 16.6 percent in August from the year ago, the largest on record going back to 2000. The smaller, 10-city index, fell 17.7 percent, the biggest decline in its 21-year history.

The Fed hopes that lower borrowing costs will entice people and businesses to spend again, which would help revive the economy. The Fed also hopes that other actions to shore up the U.S. financial system - along with lower rates - will help get credit flowing more freely again. So far, though, the central bank's steps haven't been able to turn around a panicky mind-set.

The Europeans also are weighing another rate cut.

"There is ample justification for pessimism," said John Lipsky, first deputy managing director of the International Monetary Fund, the world's financial firefighter. "Global prospects remain highly uncertain and risks of a global recession loom large," he said.

With a U.S. recession seen as inevitable, any Fed rate reduction would be aimed at relieving some of the pain.

The Fed probably will hold the door open to additional rate reductions when it acts on Wednesday, economists said. The Fed's last scheduled meeting of the year is Dec. 16.

Many predict the economy contracted in the third quarter by around 0.5 percent when the government reports Thursday on the economy's performance. If that estimate is correct, it would mark the biggest decline in economic activity since the third quarter of 2001, when the country was suffering through its last recession.

Nervous consumers are expected to have cut back sharply in their spending during the third quarter. If that proves correct, it would mark the first drop in consumer spending since late 1991, when the economy was coming out of a recession.

It can take at least six months - often longer - for the Fed's rate cuts to make their way through the economy. The Fed's previous rate reductions, however, were blunted by the fact that credit became much harder to get as banks hunkered down.

Employers, meanwhile, are likely to keep cutting back on hiring. The unemployment rate - now at 6.1 percent - is expected to hit 7.5 percent or higher by next year. Whirlpool Corp., the nation's largest home appliance maker, announced Tuesday that it will cut about 5,000 jobs by the end of next year. After the last recession, in 2001, the unemployment rate rose as high as 6.3 percent in June 2003.

A housing bust, a credit clog and a financial meltdown have collided, imperiling the U.S. economy and the global economy. Problems started out in the United States but have spread to other countries in Europe, Asia and elsewhere.

Earlier this month, the Fed and other central banks joined to slash rates, the first coordinated move of that kind in the Fed's history. That dropped the Fed's key rate down to its current 1.50 percent. It also marked an about face for the Fed, which had halted an aggressive rate-cutting campaign in June out of fears those low rate would worsen inflation. The Fed started signaling rates probably would go up to fend off inflation. The Fed shifted signals back to a rate cut when the economy worsened and the inflation threat lessened.

European Central Bank president Jean-Claude Trichet said Monday a rate cut next month is "a possibility" as moderating prices for oil and other commodities damp inflation pressures. The ECB joined the Fed in early October in cutting rates. Its key rate is at 3.75 percent.

The IMF's Lipsky said the fund stood ready to dole out more than $200 billion in loans to help struggling countries. Iceland, Pakistan, Hungary and Ukraine have all sought the IMF's help in recent weeks.