NEW YORK – The Federal Reserve on Tuesday slashed its key interest rates by an aggressive half percentage point in an attempt to counter any further damage to the U.S. economy after Sept. 11 and signaled its willingness to make further cuts.
The Fed lowered its target for the key federal funds rate to 2 percent — its lowest level since during the Kennedy administration in 1961. The central bank also dropped its more symbolic discount rate by a half-point to 1.5 percent.
The Fed rate cut was the 10th this year — and its third half-point rate cut — in the central bank's effort to stave off a recession, aggravated by the Sept. 11 attacks. The Fed last cut its rates on Oct. 2.
The move had an immediate effect on anxious stocks markets. The Dow Jones industrial average climbed 150 points to record its highest close since Sept. 10.
"Heightened uncertainty and concerns about a deterioration in business conditions both here and abroad are damping economic activity,'' the Fed said in a statement explaining its latest cut.
"Although the necessary reallocation of resources to enhance security may restrain advances in productivity for a time, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate,'' the statement added.
In response to the Fed cut, Bank One and M&T Bank announced that they were reducing their prime lending rates, the benchmark for millions of consumer and business loans, by a similar half-point to 5 percent, the lowest level since June 25, 1972. Other commercial banks were expected to follow suit.
Need to Conserve Ammunition
Analysts suggested that the central bank might begin to moderate its easing in future, partly to conserve ammunition should conditions worsen and partly because of a barrage of fiscal stimulus measures expected to come on-stream soon.
"It shows that the Fed is going to remain very aggressive and very vigilant. I think the fed funds rate is going to go lower in December, another 25 basis points. Thereafter, the Fed is going to be much more cautious,'' said Eric Green, senior economist, BNP Paribas Corp. in New York.
Drew Matus from Lehman Brothers in New York agreed. "It puts them closer to the end of their ammunition, but it shows they're not afraid to go down to the wire here if they have to,'' he said.
The latest cut comes against an increasingly grim backdrop of rising unemployment and a continued erosion of consumer confidence. The economy logged its sharpest quarterly contraction in national economic activity in the third quarter since the last recession in 1990-91.
In its statement, the Fed said it still saw weakness, rather than price pressures, as the main threat to the U.S. economy — a sign it was ready to cut rates further should gross domestic product continue to shrink, as most private forecasters expect it will into early next year.
The economy already was slowing before Sept 11, when hijacked aircraft flattened the World Trade Center in New York and damaged the Pentagon, halting much of national commerce for days and inflicting lasting scars on airline and other industries.
Last week, the Commerce Department confirmed GDP shrank at a 0.4 percent rate in the third quarter.
During October, 415,000 jobs were scrubbed from payrolls, the most in two decades, as the combined impact of the attacks and an anthrax scare braked activity throughout the economy,
Most economists foresee GDP shrinking again this quarter and many think this will continue in the first quarter of 2002, easily meeting the commonly accepted definition of a recession in which national output falls for six months or more.
Recovery Seen Next Year
The Fed's rate-cutting campaign, one of the most sustained and aggressive in the history of the central bank, has failed to light a flame under the sputtering economy but analysts say it is likely to help ignite a strong recovery next year.
In addition to the heavy dose of monetary easing, the government added direct fiscal stimulus of about $55 billion in emergency spending and industry aid since the attacks and is weighing another tax-cut and spending program worth as much as $100 billion which, if passed by Congress, will kick in fully next year.
Analysts note that with inflation reined in, the Fed has the freedom to keep trying to revive U.S. economic activity and economists believe it is likely to cut rates further, albeit at a slower pace. Interest rates are now already below the rate of the rise in consumer prices, although they are still above other inflation measures that policymakers monitor.
But a strong rebound in growth in the second half of next year, which many economists are forecasting, could quickly force the central bank to reverse course and start to raise rates again to avoid a breakout in prices, once some of the current slack in the economy is taken up.
Reuters and the Associated Press contributed to this report.