Fed delivers another rate cut

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Central bank, in second cut in a week, slashes key interest rate by half-percentage point. Play video

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The central bank's second interest rate cut in a week raises the risk of inflation and bails out the banks. Play video

NEW YORK (CNNMoney.com) -- Faced with growing risks of recession, the Federal Reserve made its second deep interest-rate cut in a week and slashed a key short-term rate by a half-percentage point Wednesday.

U.S. stocks, which had been slightly lower ahead of the announcement, surged on news of the rate cut but ended lower after a volatile final two hours of trading.

The federal funds rate - an overnight bank lending rate that affects how much interest consumers pay on credit cards, home equity lines of credit and auto loans - was cut to 3.0% from 3.5%. The rate had stood at 5.25% only four months ago.

The discount rate, which is what banks pay to borrow directly from the Fed, was also cut by a half-point to 3.5% on Wednesday. The cut was made at the request of nine of the nation's 12 Federal Reserve district bank presidents.

The Fed slashed both rates by three-quarters of a percentage point in an emergency move on Jan. 22.

One member of the Federal Open Market Committee, Dallas Fed President Richard Fisher, voted against Wednesday's cut in the fed funds rate. He argued that rates should have been left unchanged after the series of rate cuts by the central bank in recent months. Fisher is generally seen as a so-called inflation hawk who is greatly concerned with maintaining price stability.

The Fed, in its statement explaining the cut, acknowledged that the risk of inflation needs to be monitored, but said that the majority of its members believed that price pressures will moderate in coming quarters.

The rate cuts were necessary because problems in the credit markets were putting a squeeze on both consumers and businesses, the Fed said. It added that it sees growing weakness in both the job market and the battered housing market.

"Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity," according to the statement. "However, downside risks to growth remain."

The Fed also appeared to hint that it will keep cutting rates if the economy shows more signs of decline.

"The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks," the statement said.

Keith Hembre, chief economist for First American Funds, said the statement suggested a greater likelihood of more cuts than he was expecting.

"I thought that they would probably include some language to temper expectations of any additional cuts in the near term," he said. "That statement makes it sounds like they're still in motion."

Wall Street is now betting on more rate cuts in the next few months. According to federal funds futures trading on the Chicago Board of Trade, investors are pricing in a 100 percent chance of at least another quarter point cut by May and a 70 percent chance of rates being a half-point lower than there were after this move. The Fed is scheduled to meet next on March 18 and April 29-30, but has no meetings scheduled for May.

But one economist said that further rate cuts could be justified, and that it makes sense for the Fed to build on its emergency cut of a week ago, even if some see it as caving to market pressure.

"They could have gotten away with a quarter, but that risked undoing every thing they did a week earlier. They are now ahead of the curve," said Mark Vitner, senior economist with Wachovia. "

Vitner said he's not surprised that the fed funds futures indicate that investors expect more cuts. "You give them an inch, and they want a mile," he said. But he's also expecting a quarter point cut at each of the next two meetings.

"Given where the Fed says the risks lie, you have to ask yourself, 'Are financials markets going be all that less stressed by March?'" he said. "I think the answer to that is, 'Probably not.'"

But economists who are concerned about inflation criticized the Fed move, and its apparent lack of attention to price pressures.

"Higher prices are coming, even if the economy slows to a crawl," said Rich Yamarone, director of economic research at Argus Research. "We've seen price increases in company announcements, in our grocery bills and in the economic data. The Fed is telling you they're going to watch it because that's in their mandate. But I think they'll turn a blind eye to that."

The rate cuts came on a day the government reported that economic growth slowed significantly in the last three months of 2007, matching its weakest performance of the past five years. It also comes as Congress rushes to pass a $150 billion economic stimulus package to spur spending by both consumers and businesses.