Federal Reserve & Interest Rates

On Tuesday, the Federal Reserve slashed a key interest rate by three-quarters of a percentage point. This is the latest in moves by the central bank to do their best to restore confidence in the economy and troubled financial markets. The Fed cut its federal funds rate for the sixth time in the past six months, an overnight bank lending rate, to 2.25%. Although many believe the economy is in a recession, this cut comes at a time when the Fed is trying to keep the economy from slipping even lower.

Interest rate cuts are usually viewed as beneficial for the economy since they typically lead to more lending. The federal funds rate affects how much consumers pay on credit cards and home equity lines of credit, as well as the rate paid by many businesses on loans tied to banks’ prime rate. But some experts think lower rates won’t solve the credit crunch paralyzing Wall Street.

Many are worried the rate cuts will cause a continued weakening in the value of the dollar and a further spike in commodity prices — which could lead to higher prices for gas, food and imported goods.

The Federal Reserve decided to cut the key interest rates yesterday, Sunday, due to urgent concerns about the credit crisis.

The first move that the Fed decided to make was to “authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant.”

The emergency lending rate that is charged to banks was reduced from 3.5% to 3.25%. The statement released by the Federal Reserve Board stated that the “two initiatives [were] designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth.”

The move is seen as a sign that the Federal Reserve is making every move possible to keep the financial markets from collapsing. It also shows that there are still serious concerns about the slow economic growth that we are now facing.

Wall Street has not responded well. Stocks today were down by nearly 200 points at open and the world trading markets also plummeted. United States Stock futures spiraled down, and the value of the dollar has yet to rebound, even slightly.

There is a great deal of uncertainty in the credit market, with lending problems in the housing market, as well as the overall household debt in the nation. Economic conditions have continued to deteriorate despite the Federal Reserve’s best efforts. Consumer spending is low, jobs are being lost, and economic growth is happening, but at an alarmingly slow pace.

The President will be meeting with his Financial Markets advisory board today, which includes Fed Chairman Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox.

The Federal Open Market Committee is scheduled to meet yet again Tuesday. Considering current economic conditions and inflation holding steady for now, more interest rate cuts are expected. An aggressive cut of up to 75-basis points is expected.

The Department of Labor reported that the Consumer Price Index (CPI) was unchanged for February. This is positive economic news, as inflation has been a firm concern of the Federal Reserve since the series of rate cuts were made. Overall, the CPI for all urban consumers did not change, which means prices did not continue to go up last month.

The Dept of Labor Reported:

On a seasonally adjusted basis, the CPI-U was virtually unchanged in February, following a 0.4 percent rise in January. Each of the three groups–food, energy, and all items less food and energy–contributed to the deceleration. The index for food at home, which rose 0.9 percent in January, increased 0.3 percent. The moderation reflected a downturn in the indexes for fruits and vegetables, for meats, poultry, fish, and eggs, and for nonalcoholic beverages. The index for energy turned down in February as a 1.9 percent decline in the index for energy commodities more than offset a 1.7 percent increase in the index for energy services. The index for all items less food and energy was virtually unchanged after increasing 0.3 percent in January. The deceleration reflects smaller increases in the indexes for shelter, for medical care, for recreation, for education and communication, and for other goods and services, and a decline in the index for apparel.

Basically, there were some price reductions, but they were neutralized by spikes in natural gas prices. Thus, the CPI remained the same.

Prices had otherwise been building up over several months, particularly in the energy and commodity markets. This pause in pricing increases is a nice relief after a long series of increasing price pressures. The Federal Reserve now has a greater flexibility in terms of rate reductions at their upcoming meeting, to be held next week. With a small relief regarding inflation worries, it is possible that the Fed will make more aggressive rate cuts. A modest cut may still be made, but this data might encourage a deeper cut.

While inflation seems to be paused, prices are still high compared to this time last year. Prices in general are 4% higher. Considering this fact, the Reserve might choose to make modest cuts. Even so, many still expect some further cuts to be made. Economists expect inflation problems to ease in the coming months.