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Fed cuts key interest rate for a second time to guard against recession threats

| Wednesday, Oct. 31, 2007

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

The central bank lowered the federal funds rate to 4.5 percent in an effort to stimulate economic activity and keep the country from dipping into a recession. The move will make it cheaper for consumers and businesses to borrow money.

The Fed's action came on the same day the government announced that the overall economy grew at a stronger-than-expected 3.9 percent rate in the July-September quarter.

However, economists are worried that growth will be less than half that amount in the current quarter as the country struggles with a deepening housing slump.

However, Fed policymakers signaled that Wednesday's cut may be all that is needed to deal with the economy's trouble.

The panel said in a brief statement explaining its action that the Fed after the second rate cut judges that "the upside risks to inflation roughly balance the downside risks to growth."

By stating that risks are now roughly balanced, the Fed could be signaling that it judges that further rate cuts will not be necessary.

The Fed's decision came on a 9-1 vote with Thomas Hoenig, president of the Kansas City regional Fed bank dissenting, arguing that he preferred no change in the funds rate.

Commenting on the economy, the Fed struck a more positive tone than it did last month when it expressed concerns about the toll the August credit crisis would take on housing and the overall economy.

In the current statement, the Fed said, "Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance."

The central bank said the pace of the economic expansion "will likely slow in the near term, partly reflecting the intensification of the housing correction."

On inflation, the central bank said the reading on core inflation, which excludes energy and food, had "improved modestly this year" but expressed worries about what the recent increases in energy prices and other commodities might do to inflation pressures going forward.

The committee said that "some inflation risks remain," a signal that it will be hesistant to cut rates further because of concerns on inflation.

The Fed had pushed the federal funds rate up a record 17 consecutive times in quarter-point moves over two years. The last increase occurred in June 2006. From that time until last month, the rate was left unchanged as the central bank watched to see whether its credit tightening had the desired effect of slowing the economy enough to lessen inflation pressures.

However, the Fed's goal of a soft-landing in which growth slows and inflation is contained has been threatened by the most severe housing downturn in more than two decades. Economists are worried that the credit crisis this summer will make home sales and prices fall even further, threatening consumer confidence and causing consumers to cut back on their spending.

Bernanke, who took over as Fed chairman in February 2006 from Alan Greenspan, came under criticism in August when the Fed left rates unchanged and declared that inflation was still the primary threat facing the economy.

But two days after that meeting when a severe credit crunch hit financial markets around the globe, the Fed went into action, providing billions of dollars in cash to the U.S. finanancial system, slashing the rate at which it makes direct loans to banks and then on Sept. 18 cutting the funds rate by a bigger-than-expected half point.

"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."

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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