Fed Lowers Key Interest Rate by a Quarter Point !!!! What is Next???

WASHINGTON, Oct. 31 — Federal Reserve policy makers, worried that the meltdown in housing could continue to slow the entire economy, cut their benchmark interest rate today by a quarter point to 4.50 percent, from 4.75.






Fed’s StatementToday’s rate cut follows an unusually large one-half percentage point in September, when the volatility in the markets and problems in housing, led the Fed to take action.

“Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance,” the Fed said in a statement. “However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.”

One Fed governor, Thomas M. Hoenig, voted against the rate cut. The board also approved a 25-basis-point decrease in the discount rate to 5 percent.

Financial markets had put heavy pressure on the central bank to reduce short-term rates a second time. The markets fell quickly after the announcement, but also started to recover somewhat almost as quickly.

But policy makers faced a difficult decision because the overall economy has yet to show much sign of being crippled by the twin problems in housing and mortgage finance.

Analysts said the central bank’s decision was akin to taking out an additional insurance policy against recession. Housing downturns have preceded 8 of the last 10 recessions, and this year’s downward spiral is shaping up to be the deepest in history.

Yet just a few hours before the Fed announced its decision, the Commerce Department reported that the nation’s gross domestic product expanded at a healthy pace of 3.9 percent in the quarter that ended Sept. 30.

Consumer spending, which accounts for more than two-thirds of America’s economic activity, climbed 3 percent. Job creation has slowed in recent months, but employers are still hiring more than firing and wages are rising faster than inflation. The unemployment, at 4.7 percent, is low and has barely budged.

The most recent data on home sales, housing prices and construction have all been worse than analysts expected. Defaults have climbed sharply on mortgages to subprime borrowers with weak credit histories, and analysts are predicting anywhere from 500,000 to 2 million foreclosures on subprime loans by the end of next year.

Wall Street firms and major banks have announced billions of dollars in losses on mortgage-backed securities in the last several weeks, and Merrill Lynch’s $8.4 billion write-down was among the factors that led to the ouster of its chief executive, E. Stanley O’Neal, earlier this week.

Fed officials and private economists alike have predicted that the housing market has yet to hit bottom. Housing starts in September were down 31 percent from the year before. Sales of existing homes have dropped 30 percent since their peak in 2005, and the supply of unsold homes last month reached its highest level in more than 19 years.

The nationwide average price of homes have declined almost 5 percent in the last year, the first time on record that has happened in the United States. On Tuesday, Standard & Poor’s reported that its Case-Schiller index of housing prices in 20 major cities had declined 4.4 percent in August, compared with a year earlier. That was the eighth consecutive monthly decline, and the steepest since April 1991.

“If the Fed is in the business of managing risks, as it claims to be, the argument in favor of easing is, in our view, overwhelming,” wrote Ian Shepherdson, an economist at High Frequency Economics, in a research note on Tuesday.

But at least some Fed officials have worried about reacting too strongly. The president of the San Francisco Fed, Janet Yellen, cautioned in a speech last month that the Fed cut rates dramatically after the Russian financial collapse in August 1998. Then, as now, credit markets began to freeze up as investors worried about defaults. But the fear abated and the economic boom did not slow that year.

At the Fed’s policy meeting on Sept. 18, 5 of the 12 regional banks did not request a reduction in the discount rate, the rate at which banks can borrow directly from the Fed. That was a quiet sign that some Fed presidents did not yet see the need for lower rates at that time.

Lyle E. Gramley, a former Fed governor and now a senior adviser to the Stamford Washington Research Group, said some policy makers were worried that rising wages and slower productivity growth could aggravate inflation.

“Unless productivity improves or the rise in compensation slows down, unit-labor costs will be rising too rapidly to keep core inflation down to 2 percent,” Mr. Gramley said. “That’s what’s got them worried.”

But Fed officials were under heavy pressure from financial markets. Prices of Fed-funds futures, which provide a way of betting on the Federal funds rate, showed that investors placed the odds of a rate cut on Wednesday at 96 percent.

Had the central bank decided to leave interest rates unchanged, without any advance warnings from policy makers, the stock markets would likely have plunged in panic.

Instead, policy makers were expected to give investors the rate cut they expected but also to warn against assuming additional rate cuts later this year.