NEW YORK – The Federal Reserve shocked financial markets Wednesday by cutting key short-term U.S. interest rates a half percentage point, citing its need to spur a rapidly flagging economy.
It marked the most aggressive credit easing during Federal Reserve Chairman Alan Greenspan's nearly 14 years at the helm and sent a clear message that the central bank is prepared to do whatever it can to prevent a recession.
The Fed action brings the federal funds rate overnight bank lending rate down to 4.5 percent from 5 percent. The more symbolic discount rate on Fed loans to banks will fall to 4.0 percent.
The Fed stunned financial watchers by cutting the rate between scheduled meetings of its policymaking Federal Open Market Committee. The last time the Fed changed rates between scheduled meetings was on January 3.
"Tactically, this was a masterful stroke on the part of the Fed because the markets had completely eliminated the possibility of a Fed cut before the next meeting," said David Jones, chief economist at Aubrey G. Lanston & Co. in New York.
The relatively rare move followed an early morning conference call between Greenspan and other FOMC members and sent Wall Street — which had given up hope that the Fed would cut rates again before its meeting on May 15 — soaring.
The Dow Jones industrial average enjoyed its third biggest one-day point gain in history, rising by 399.10, or 3.9 percent, to 10,615.83. The technology-heavy Nasdaq rose 156.22, or 8.1 percent, its fourth best percentage gain, to close at 2,079.44.
In a statement issued to explain its decision, the Fed said progress was being made in reducing overstocked inventories and added that consumer spending and housing were holding up reasonably well.
"Nonetheless, capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen capital spending going forward, the Fed said.
"This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, threatens to keep the pace of economic activity unacceptably weak," it added.
A further decline in investment spending, combined with the negative effects on consumer spending from a falling stock market and with economic weakness in other countries, "threatens to keep the pace of economic activity unacceptably weak,'' the Fed said.
"This is exactly the right decision, made at exactly the right time," said Gordon Richards, chief economist for the National Association of Manufacturers. "It is much-needed adrenaline for a weak economy."
The big rally on Wednesday was one of Wall Street's strongest performances since the Fed began the series of rate reductions on Jan. 3. Its reduction that day, the first cut outside of a regular meeting since the Asian crisis of 1998, triggered a 300-point Dow rally.
The market was disappointed in the next two rate cuts, which came during regularly scheduled Fed meetings, especially the March 20 announcement when investors had been hoping for a bigger three-quarter-point Fed move.
Analysts said Greenspan and his colleagues clearly had investors in mind in the timing of Wednesday's move, hoping to bolster consumer confidence, which has been sagging as Americans watched trillions of dollars of paper wealth evaporate over the past year.
The telephone conference call among Fed policy-makers that accompanied the rate decision began at 8:30 a.m. EDT. The announcement of the change came shortly before 11 a.m.
Greenspan has said in congressional testimony this year that the biggest threat of a recession would come from a sudden plunge in consumer and business confidence, which could be triggered by a steep stock market sell-off.
The Fed announcement said risks to the economy remained "weighted mainly toward" weakness rather than inflation, and analysts took that language to signal further rate cuts were likely. The Fed was given maneuvering room by Tuesday's benign report on inflation which showed consumer prices were up just 0.1 percent in March.
Many analysts believed the next rate cut would occur at the Fed's regular May 15 meeting, but they were uncertain whether it would be another half-point cut or Greenspan's more normal quarter-point reduction. The rate size will depend on upcoming indicators, the analysts said.
While job losses in March were the largest since 1991, other recent indicators have presented a mixed picture. The government said this week that industrial production rose an unexpectedly strong 0.4 last month, the first gain after five straight losses and a signal that the worst may be over for manufacturers.
The trade deficit narrowed dramatically in February, but a key gauge of future activity, the index of leading indicators, fell for a second straight month in March, according to two reports released Wednesday.
Many analysts who had worried that the gross domestic product could turn negative in the first quarter are now revising their forecasts to show growth perhaps as strong as 1.5 percent. A recession is often defined as two consecutive quarters of falling GDP.
Martin Regalia, chief economist of the U.S. Chamber of Commerce, said he was growing more optimistic that the country would avoid a recession.
"Some have said the Fed's moves between meetings indicate that the central bank knows something that we don't and they are running scared. I don't believe that at all," Regalia said. "Our forecast has us avoiding a recession with growth rebounding as the year progresses."
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