Fed slashes funds rate to historic low

[frawin]

My old Money and Banking Class College Professor would be pounding his desk and ranting that this cannot be. The Interbank rate is virtually -0- and yet everyone I talk to tells me the Banks are not approving loans and/or loaning money. My minor was in Economics, which included Money and Banking but we never discussed anything like what is happening today.

Fed slashes funds rate to historic low

Rates to stay low for the foreseeable future, economists say

Tuesday, December 16, 2008

U.S. Federal Reserve cut its key interest rate to an historic low range Tuesday. The Federal Open Market Committee voted unanimously to reduce the target fed funds rate for interbank lending from 1% to a range of zero to 0.25%, the lowest since the Fed started publishing the funds target in 1990.

Economists had expected a smaller cut of just 0.5 percentage point, and hadn't expected the Fed to set a range.

In Tuesday's statement the Fed said since its last meeting, "labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further."

"The Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time," the Fed said, adding it will "employ all available tools' to promote growth and maintain price stability."

Meanwhile, inflationary pressures have diminished appreciably. "In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters," the Fed stated.

Voting for the FOMC monetary policy action were: Ben Bernanke, chairman; Christine Cumming; Elizabeth Duke; Richard Fisher; Donald Kohn; Randall Kroszner; Sandra Pianalto; Charles Plosser; Gary Stern; and Kevin Warsh.

In a related action, the Fed also lowered the discount rate paid by commercial and investment banks for Fed loans by 0.75 percentage point to 0.5%.

Officials also signaled a new phase for policy in which lending programs financed by the Fed's ballooning balance sheet, a process known as quantitative easing, replace the federal funds rate as the Fed's primary policy tool.

Rates to stay low for the foreseeable future, economists say

Economists say that they expect the U.S. Federal Reserve Board to keep rates in its new rock-bottom range for the foreseeable future as it tries exceptional measures to revive the US economy.

The U.S. FOMC announced that it would reduce the fed funds rate by 75-100 basis points today, and will target a range of 0.00-0.25%. The Fed will no longer pursue a specific point target for the fed funds rate, but instead will target a narrow range, notes TD Economics.

"The statement provided the clearest indication that the Fed will engage in unconventional monetary policy tools," TD says. "Indeed, the statement was a dramatic departure from the past in noting that 'the Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability'."

The Fed also says that it "will continue to consider ways of using its balance sheet to further support credit markets and economic activity."

RBC Economics says that "there is little doubt that the U.S. economy slipped further into recession in the fourth quarter with November's labour report showing an unexpectedly large number of job cuts, which reinforced forecasts that real GDP will contract at a much faster pace than the third quarter's modest 0.5% slip. Data reports, including today's release showing that housing starts fell to the lowest level since records began in 1959, raise the risk that the economic weakness could intensify going into 2009 and corroborate the Fed's assessment that "the outlook for economic activity has weakened further" since their last meeting. " At the same time, RBC points out, inflation pressures have been easing with the November consumer price numbers showing a sharp decline in the overall annual inflation rate (to the lowest rate since June 2002) with the core index also falling more than expected.

"The Fed's aggressive rate moves in recent months combined with today's commitment to keeping policy accommodative for 'some time' are aimed at both boosting confidence and leading to lower funding costs," RBC says.

"The bottom line, then, is clearly that the Fed will keep the fed funds rate at 0.00-0.25% for a sustained period of time and will engage in unconventional monetary policy both in the form of quantitative easing and the buying of securities, all in an effort to resuscitate the ailing U.S. economy," TD concludes.

"While the recent data have certainly been grim, we maintain that the combination of the Fed's aggressive moves and the government's policy actions will be effective over time," concludes RBC Economics. "The consistent declines in the three-month LIBOR rate hints that the banking system, while still impaired, is starting to respond to these policy measures. While today's actions are the end of the line for rate cuts, the Fed will remain vigilant in keeping stimulus in the system, rates low throughout the curve and gear policy to addressing distressed areas as they appear."