Tags: fed | cut | rates

Fed Cuts Borrowing Rates by Quarter Point

Wednesday, 31 Oct 2007 01:17 PM

The Federal Reserve, confronted with surging oil prices and a slumping housing market, on Wednesday cut a key interest rate by a quarter-point, the second rate reduction this year.

Many analysts said this rate reduction probably will not be the last either, as the central bank keeps reducing rates to help the economy overcome a host of problems.

The Fed cut the federal funds rate, the interest that banks charge each other, for the first time in four years at its September meeting, reducing it to 4.75 percent. Responding to that move, commercial banks cut their prime lending rate, the benchmark for millions of consumer and business loans, by a half-point as well to 7.75 percent.

The economy's troubles include the worst slump in housing in more than two decades and a credit crunch that roiled financial markets this summer when investors suddenly became concerned about mounting losses from defaults on subprime mortgages.

With lenders tightening mortgage standards, marking it harder for prospective buyers to qualify for loans, and defaults continuing to rise, the slump in housing has deepened.

Financial markets also have a new worry in the latest surge in oil prices. Crude oil prices have hit records above $93 per barrel.

The worry is that the combination of the deep slump in housing, a lingering credit-crunch and rising oil prices will severely dampen consumer spending, the economy's main growth engine, in the months ahead.

''The economy is facing a perfect storm right now of a crisis-related tightening of credit, higher oil prices and lower house prices,'' said David Jones, chief economist at DMJ Advisors, a Denver forecasting firm. ''We are going to see a significant slowing in growth.''

Jones forecast that the overall economy, as measured by the gross domestic product, will slow to a rate of 1.5 percent for this quarter and will dip even lower to a rate of 1.3 percent in the first three months of next year.

That sluggish pace would make the economy vulnerable to some type of economic shock that could push GDP growth into the negative territory that signals a recession.

''The consumer is getting squeezed right now between falling home prices and rising oil prices,'' said David Wyss, chief economist at Standard & Poor's in New York. ''They have got to slow down. It is just a question of how much and how fast.''

In two worrisome developments, the Conference Board's consumer confidence index fell for a third consecutive month in October, dropping to the lowest level in two years, while the S&P/Case-Shiller Index of home prices, based on 20 cities around the country, dropped by a record 5 percent in August.

Still, the economy showed strength in reports released before the Fed meeting Wednesday. In the third quarter, gross domestic product grew at a brisk 3.9 percent pace, faster than economists had expected, the Commerce Department reported Wednesday.

A second report showed construction spending rose 0.3 percent in September, the best showing in four months, with commercial and private building more than offsetting the weak home market.

But the ongoing credit and housing problems and the renewed surge of energy prices are expected to exact a toll in upcoming months with the economy not expected to regain its balance until mid-2008. Many analysts believe that in addition to a rate cut Wednesday, the Fed will cut rates at its final meeting of the year in December and possibly at its January meeting as well.

Lyle Gramley, a former Fed board member and now an economist with Stanford Financial Group, put the chances of a recession at around 40 percent, saying the Fed's primary concern right now is what is happening in housing and how much of a spillover that will have on the overall economy.

''It is possible that the housing industry will take us over the edge into a recession,'' he said, noting that every housing downturn of the past 60 years with the exception of two have triggered recessions.

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