Fed, Central Banks Cut Rates to Aid World Economy

Published October 08, 2008

| Associated Press

The Federal Reserve, acting in coordination with other global central banking authorities, cut a key U.S. interest rate by half a percentage point Wednesday to steady a teetering economy.

The Fed reduced its key rate from 2 percent to 1.5 percent.

In Europe, which also has been hard hit by the financial crisis, the Bank of England cut its rate by half a point to 4.5 percent, while the European Central Bank sliced its rate to 3.75 percent.

Other central banks also taking part include the banks of Canada, Sweden, and Switzerland.

China also cut its key interest rates Wednesday for a second time in less than one month to stimulate slowing economic growth amid the global credit crisis.

Fed Chairman Ben Bernanke and his colleagues ratcheted down their key rate by 0.5 percentage point to 1.5 percent. The action revives the central bank's rate-cutting campaign which had been halted in June out of concerns that those low rates would worsen inflation. Since then, however, economic and financial conditions have dangerously deteriorated, forcing the Fed to reverse course.

The fact that the Fed felt it couldn't wait until its regularly scheduled meeting on Oct. 28-29, underscored the urgency of the situation.

The Fed took the action in a coordinated move with other central banks, which also were cutting their rates.

"The pace of economic activity has slowed markedly in recent months," the Fed said "Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."

Although inflation has been high, the Fed believes that the recent drop in energy prices and the weaker prospects for economic activity have reduced this threat to the economy.

The Wednesday cuts come as markets in Asia and Europe sink amid waning confidence, Britain steps in to support banks, and Russia closes its main stock market for two days.

In addition, the Fed reduced its emergency lending rate to banks by half a percentage point to 1.75 percent. Given the intense credit crisis, banks have been ramping up their borrowing from the Fed's emergency "discount" window.

In response, the prime lending rate for millions of borrowers will drop by a corresponding amount. The prime rate applies to certain credit cards, home equity lines of credit and other loans.

The hope was to spur nervous consumers and businesses to spend more freely again. They clamped down as housing, credit and financial problems intensified last month, throwing Wall Street into chaos. Many believe the country is on the brink of, or already in, its first recession since 2001.

The Fed's last rate cut was in late April, capping one of the most aggressive rate-cutting campaigns in decades as it scrambled to shore up the faltering economy. After that, the Fed moved to the sidelines, holding rates steady as zooming food and energy prices during that period threatened to ignite inflation. In the past few months, energy prices have retreated from record highs reached in mid-July, giving the Fed more leeway to drop rates again.

At its last meeting in September, the Fed struck a more dire tone about the economy, hinting that a rate reduction once again could be in the offing.

Even with the unprecedented $700 billion financial bailout quickly signed into law by President Bush on Friday, the failing economy and the jobs market probably will get worse. Many believe the economy will jolt into reverse later this year — if it hasn't already— and will stay sickly well into next year.

One of the most crucial pillars of the economy — the jobs market — has cracked, and wage growth is slowing. This means that consumers will be even more hard-pressed to spend in the fashion that helps grow the economy.

Increasingly skittish employers slashed payrolls by 159,000 in September, the most in more than five years. A staggering 760,000 jobs have disappeared so far this year. The unemployment rate is 6.1 percent, up sharply from 4.7 percent a year ago.

The unemployment rate could hit 7 or 7.5 percent by late 2009. If that happens, it would mark the highest rate of joblessness since the months immediately following the 1990-91 recession. Some economists say the jobless rate could rise even more before the situation starts to get better.

Mounting job losses, shrinking paychecks, shriveling nest eggs and rising foreclosures all have weighed heavily on American voters. The economy is their No. 1 concern, polls have shown.

Spooked consumers and businesses have pulled back so much that some analysts fear the economy stalled — or even worse, shrank — in the July-to-September quarter. Many predict the economy will contract in both the final quarter of this year and the first quarter of next year, meeting the classic definition of a recession.

The financial crisis that intensified in September is forcing a seismic shake-up on Wall Street.

Lehman Brothers, the country's fourth-largest investment bank, filed for bankruptcy protection. A weakened Merrill Lynch, deciding it couldn't go it alone anymore, found help in the arms of Bank of America. American International International Group was thrown a financial lifeline. And, the last two investment houses — Goldman Sachs and Morgan Stanley — decided to convert themselves into commercial banks to better weather the financial storm. The number of banks that have failed this year are up sharply from last year. On Friday, Wachovia Corp. said it will be acquired by Wells Fargo & Co. wiping out Wachovia's previous plan to sell its banking operations to rival suitor Citigroup Inc.

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