NEW YORK (CNNfn) - The Federal Reserve cut short-term interest rates by a quarter of a percentage point Tuesday, its seventh cut this year as part of a continuing effort to keep the U.S. economy from slipping into a recession, and left the door open for further cuts.|
The federal funds rate, the central bank's target for an overnight bank lending rate, now stands at 3.50 percent, its lowest level since March 1994. The Fed also cut the seldom-used discount rate to 3.0 percent from 3.25 percent.
Economists had expected Tuesday's rate cut, but were mostly concerned about what the Fed would say about its future actions. In a statement accompanying its decision, the Fed indicated it may not be done cutting rates for the year, saying it's still concerned about the sluggishness of the economy.
"It retained its easing bias, which leaves the Fed open to further easing in the future if need be," Merrill Lynch chief economist Bruce Steinberg said.
"We believe it is possible that there will be another Fed easing at the next [policy] meeting on Oct 2."
U.S. stock markets dropped sharply after the announcement, while U.S. Treasury bond prices fell slightly.
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Most analysts had expected the cut to have little or no positive impact on U.S. stock markets, which have yawned at Fed rate cuts all year. Since the last cut, on June 27, the Dow, Nasdaq and S&P 500 have all fallen.
In order to post meaningful gains, the stock markets likely will need to be convinced that the U.S. economy is beginning to recover from a year-long economic slowdown that's eroded corporate profits.
"I think that the market would have rather seen sort of a shift to neutral, maybe signaling the end of the rate cuts, but I think that [the Fed] saying that they are still on alert [shows] that the economic weakness isn't over yet," said Peter Blatchford, head of proprietary trading at Miller Tabak & Co.
Despite relatively good news Monday about leading economic indicators and reports last week of falling prices, continuing strength in the housing market, a possible recovery in the labor market and stabilization in manufacturing, the Fed believed, as did many economists, that the economy was still slow.
In its statement, the Fed noted consumer spending -- which drives two-thirds of the U.S. economy -- was still strong, but also said it was concerned about a continuing slump in corporate profits, capital spending and growth abroad.
"Although long-term prospects for productivity growth and the economy remain favorable, the Committee continues to believe that... the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," the Fed said.
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Since the beginning of 2001, the Fed has cut the federal funds rate seven times, lowering it from 6.5 percent to 3.5 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 economy so far has avoided a recession, defined as two consecutive quarters of shrinking gross domestic product (GDP) growth. Economists think second-quarter GDP could be revised downward and into negative territory, especially after a report Wednesday showed inventories and sales at U.S. businesses falling and another report Friday showed the U.S. trade deficit with other nations widening.
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.
M&T Bank Corp. (MTB: down $0.17 to $80.23, Research, Estimates) was the first out of the gate, cutting its prime lending rate to 6.50 percent from 6.75 percent, effective Wednesday. Bank One Corp. (ONE: down $0.43 to $37.61, Research, Estimates) followed by cutting its prime rate to 6.5 percent from 6.75 percent.
Consumer spending is important to the Fed because it drives two-thirds of the U.S. economy, and continuing corporate profit woes could lead to more job cuts, which could discourage consumers from spending -- a "nightmare" for the Fed, former Fed Vice Chairman Alan Blinder told CNNfn's Money Gang program. (222K WAV) or (222K AIF)
Because the U.S. government has begun mailing advance payments for 2001 tax credit, commonly called "rebate" checks, to taxpayers, some analysts think the Fed will decide there's already enough stimulus in the system and will decide against cutting rates again.
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"There are many who, on a theoretical basis, would argue that now is the time the Fed should begin pulling back because we'll be feeling the bulk of the rate cuts when we already should have started tightening again," Bank One chief economist Diane Swonk told CNNfn's Money Gang.
Swonk and some other analysts worry that too much money flooding the economy will cause inflation, which Swonk said would be harder to fight than the economic slowdown. (410K WAV) or (410K AIF)
But the Fed hasn't been concerned about inflation for some time, and it's still apparently not worried.
"The associated easing of pressures on labor and product markets is expected to keep inflation contained," the Fed said in its statement Tuesday.
The bond market, at least, thinks the Fed will likely cut again. The implied yield on the federal funds futures contract for November, after the Fed's next policy meeting, is at 3.275 percent, compared with the current Fed funds rate of 3.50 percent.
According to an Aug. 16 Reuters poll, 12 of 25 "primary dealers" -- investment banks that trade directly with the Fed in fixed-income markets -- expected another quarter-point rate cut by the end of the year.
-- from staff and wire reports