Wednesday, September 19, 2007

Fed Cuts Interest Rate

by Amy Lillard

This year has been a year of ups and downs for the housing market. In our continuing series, we chronicle news affecting the housing market and its major players.

In a move that has been anticipated for weeks, the Federal Reserve cut U.S. interest rates by a larger-than-expected half-percentage point yesterday.

The move is one intended to protect the economy from the increasing effects of a housing slump and stock market turbulence. It was met with immediate rallies on Wall Street and the Dow Jones industrial average's best daily percentage gain since 2003.

The interest rate, formally known as the federal funds rate, which governs overnight loans between banks, has stayed firm at 5.25 percent since June 2003. The decision took the rate down to 4.75. The Fed also cut the discount rate it charges for direct loans to banks by a half-point to 5.25 percent.

In a statement, the Fed said its move was a preemptive strike to eliminate the potential impact of market turmoil on the economy.

"Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time," it said. "The committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth," it said.

Many analysts and industry experts applauded the move, congratulating the Fed for taking note of the increasingly volatile economic situation. Others, however, worried the Fed's move would only encourage inflation.

Commercial banks followed the Fed, cutting the prime rate they charge their best customers for loans. Often a cut by the Fed initiates a series of rate cutting by economic organs. It remains to be seen if this will happen in this case.

There has been a landslide of evidence pointing to a hit in general economic activity, after a prolonged housing market slump and wild highs and lows in financial markets over the summer. In addition, employment figures show the first drop in employment in four years occurring in August, confirming that housing market strains are affecting businesses and households. Finally, reports on retail sales and industrial output in August also showed some softness.

The Fed has been busy this summer because of these signs, injecting cash into the banking system to keep roller coaster markets functioning normally, and issuing a surprise cut to the discount rate. This last move came with an acknowledgement that economic risks were increasing. The cut this week seemed to be a response to this growing risk.

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