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Fed cuts rates a 1/2 point
May 15, 2001: 5:09 p.m. ET

U.S. central bank makes fifth cut of 2001, leaves door open for more action
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NEW YORK (CNNfn) - Federal Reserve policy makers cut interest rates Tuesday by one-half of a percentage point, their fifth cut this year in a continuing effort to keep the United States economy from slipping into recession.

The Fed, in a statement accompanying its decision, also indicated it may not be done cutting rates for the year, saying it still is concerned about the sluggishness of the economy.

The central bank said its policy makers cut the target for the federal funds rate, an overnight bank lending rate, by half a percentage point to 4.0 percent. It also lowered the rarely used discount rate, for loans by the Fed to banks, a half-percentage point to 3.5 percent.

U.S. stock markets see-sawed after the announcement and were little changed at the closing bell. Most analysts expected little market reaction to the rate cut, saying any cut smaller than half a percentage point could have led to selling.

"The (Fed's) move was widely expected in the market," said Gemma Wright, market strategist at Barclays Capital.

Biased toward further cuts

Most economists expected the cut, too, and were mainly interested in what the Fed would say about its possible future actions. The Fed's stance changed little from when it cut rates on April 18 and said the risks for the economy were "weighted mainly toward ... economic weakness."

"The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward," the Fed statement said.

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graphicCNNfn's Tim O'Brien reports from Washington on Fed rate cut.
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"This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy."

"They haven't changed (their bias)," said Kevin Logan, senior economist with Dresdner Kleinwort Wasserstein. "The weakness in corporate profits is a problem, and investment continues to decline."

Unlike its April 18 statement, however, the Fed did not hint at any inter-meeting cuts, meaning any future cut would come at its June 26-27 meeting.

"It is only six weeks until the next meeting," said Carol Stone, deputy chief economist at Nomura Securities International. "I doubt they will have to go between meetings. There is the probability of at least a (0.25 point) cut and more likely a (0.5 point) cut in June."

Diane Swonk
Bank One chief economist
Bank One chief economist Diane Swonk told CNNfn's Money Gang program that the Fed's statement left it some wiggle room. (321K WAV) or (321K AIF)

Jobs data may have swayed the Fed

Since the beginning of 2001, the Fed has cut the federal funds rate five times, lowering it from 6.5 percent to 4.0 percent, its biggest series of cuts since it carved 5 percentage points from the rate between July 1990 and September 1992 at the end of the last recession.

The Fed had some conflicting data to sort through when making its decision this time:

         The Fed's report Monday on industrial output in April was unexpectedly weak, as manufacturing continues to bear the brunt of the economic slowdown.

         Government reports on April retail sales and wholesale prices last Friday showed surprising strength.

         The closely watched University of Michigan consumer sentiment index was higher than expected in May.

         May 4's Labor Department report of surging job cuts and a higher unemployment rate in April was an ominous note for consumer confidence -- and the economy in general, since consumer spending accounts for two-thirds of economic activity.

But the unemployment data and their possible effect on consumer confidence probably affected the Fed the most when it decided to cut rates, many analysts said.

The Fed cuts rates to encourage the nation's biggest banks to cut their own interest rates, making money more readily available to consumers and businesses in the hope that they'll spend more and boost the economy.

(For more on how interest rates affect you, click here.)

Shortly after the Fed's announcement Tuesday, in fact, Bank of America Corp. (BAC: Research, Estimates) and Bank One Corp. (ONE: Research, Estimates) cut their prime lending rate to 7 percent from 7.5 percent.

But Bob Van Order, chief economist with mortgage lender Freddie Mac, said home buyers shouldn't get too excited about the latest rate cuts.

"This rate cut should not affect mortgage rates," Van Order said. "For 30-year fixed mortgages, we'll be in the low 7.0 percent. I think the housing market is going to slow down but still be strong."

Inflation risk looming?

Interest-rate activity usually takes months to filter through the economy, and the Fed may be cutting rates aggressively, ignoring the risk of inflation, to buoy consumers' spirits while they wait for the cuts to take effect.

Some analysts think the Fed should start paying attention to inflation, and the price of the 30-year Treasury bond fell after the Fed's announcement, as traders worried inflation would hurt the long-term bond's value.

Alan Greenspan
The Fed Chairman on his way to Tuesday's meeting of Fed policy makers
"They've eased (2.5 percent) since the beginning of the year, and with that starting to kick in and the tax cuts expected later this year, I don't think they want to cut too rapidly now," said Joe Shatz, fixed income strategist with Merrill Lynch. "The cut has caused Treasury curve steepening, as some players fear the Fed may overshoot, causing inflation."

(For more on the Fed and rates, click here.)

Dresdner Kleinwort Wasserstein's Logan, on the other hand, said the Fed would not be swayed by fears of inflation.

"Contrary to what people in the market are saying, inflation is not a problem to the Fed," Logan said, "because an economic slowdown is invariably followed by a rise in inflationary pressures."

Stock markets withhold judgment

The Fed's cuts this year have gotten mixed reviews from Wall Street. The markets were surprised when the Fed cut rates on April 18, a day when markets already were rallying, and they shot higher.

On March 20, on the other hand, many investors were hoping the Fed would cut rates by 0.75 percent and got a 0.5-percent cut instead. Markets fell as a result.

Henry Herrmann, chief investment officer at Waddell & Reed, said the stock market would need to see real improvement in the economy before it begins a strong rally. "They (stock markets) are going to be watching the jobs market and what the consumer is doing." graphic

-- from staff and wire reports