The Federal Reserve cut short-term interest rates by a quarter of a point today, taking them to their lowest level since 1958.
Though the move was an effort to bring the long economic downturn to a halt, it evidently disappointed the stock and bond markets when the Fed rejected a half-point cut, explaining that the economy appeared to be improving but could still benefit from easier credit. Stocks and bonds fell after the announcement — at midafternoon on Wednesday, June 25 — with the Standard & Poor's 500 index closing at 975.32, down 8.13 points.
“Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing,” the Fed's statement read. “The economy, nonetheless, has yet to exhibit sustainable growth.”
The fall in the Fed's benchmark rate, to 1 percent from 1.25 percent, will quickly reduce rates on many business, home equity and credit card loans, as well as the return on money market funds. Mortgage rates, which are set by the market, are unlikely to change significantly, economists said, because investors had expected the Fed to act. Retirees and other people who rely on fixed investments for income will take an effective pay cut. But the overall decline in borrowing costs for households and companies is likely to help the economy, analysts said.
The Fed has cut rates 13 times since the beginning of 2001, first in a failed effort to prevent a recession and more recently in hopes of halting a period of slow growth and persistent layoffs. But the hangover from the 1990's boom, combined with wars in Iraq and Afghanistan and a series of corporate scandals, has caused the worst hiring slump in 20 years and the longest one since the period before World War II.
Most worrisome to Fed officials, a continuation of the downturn would increase the likelihood of deflation, a sustained decline in prices that could cause wages to fall and debts to become effectively larger. While reiterating that they consider the risk small, officials said today that the chance of “an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level.”
The economy has recently shown signs of improvement, like increases in manufacturing activity and retail sales, which appear to have pushed the Fed toward the smaller rate cut. A recently passed tax cut, the already low level of interest rates and this year's decline in the dollar, which helps American companies compete with foreign rivals, have also caused most economists to predict a rebound in coming months.
But most forecasters and Fed officials have been predicting a return to healthy growth since early last year, only to be surprised by the depth of the problems created by the bubble in stocks and business spending, particularly on technology. A further decline in interest rates will not necessarily cause companies to build factories or buy more equipment, some economists say.