The Fed’s top policy-setting group said in a statement, ”Today’s additional monetary easing should prove helpful as the economy works its way through this current soft spot.”
In its statement, the central bank emphasized concerns about the economic recovery amid rising worries about how a possible war with Iraq would affect consumer and business confidence.
“Incoming economic data have tended to confirm that greater uncertainty, in part attributable to heightened geopolitical risks, is currently inhibiting spending, production and employment,” the Fed said.
By lowering short-term interest rates, Fed policy-makers hoped to spur economic growth by motivating consumers to spend more and businesses to ramp up investment.
Commercial banks’ prime lending rate — the benchmark for many consumer and business loans — moves in lockstep with the funds rate. As a result of the Fed’s decision, many banks were expected to announce a similar half-point reduction, lowering the prime rate to 4.25 percent, which would be its lowest standing since May 1959.
The interest rate cut was the first of this year — after 11 reductions in 2001 — and reflected concern the economy was losing steam.
The economy grew throughout the four quarters ending with this year’s third quarter at an average annual rate of around 3 percent. But the recovery seemed to be on weaker ground towards end of the third quarter.
On Friday, the Labor Department said the economy shed 5,000 jobs in October. This news was followed by Monday’s Commerce Department announcement that orders to U.S. factories dropped 2.3 percent in September after a smaller August decrease.
And the private Conference Board said on Oct. 29 that its Consumer Confidence Index slid in October to a nine-year low of 79.4 — a disheartening sign with the key holiday shopping season between Thanksgiving and Christmas on the horizon.
One benefit of cheaper credit is that it may sustain growth in the housing sector, which has been one of the bright spots in a patchy economic picture. Low mortgage rates have spurred homebuilding and sales and enabled existing homeowners to refinance and to spend the money they save on monthly payments.
Stocks zigzagged near unchanged after the Fed’s announcement. Fed policymakers also announced they were dropping a policy of bias toward easing rates, saying the risks to the economy are now balanced between inflation and weakness.
“[That shift] leads people to believe this is the last of the rate cuts, and if that’s the case the market is saying that that takes away the boost [to the markets],” said Michael Kayes, chief investment officer at Eastover Capital Management told Reuters.