In a surprise move that sparked a furious rally on Wall Street and sent bond yields tumbling, the Federal Reserve Board slashed interest rates by one half of a percentage point for the fourth time this year. The April 18 cut reduced the benchmark federal funds rate to 4.5 percent — its lowest level since August 1994.
Officials said they took the extraordinary step of cutting rates between regularly scheduled meetings yet again to combat weakness in corporate and consumer spending and investment. The Fed’s Federal Open Market Committee, which sets interest rate policy for the broader government agency, usually changes rates at one or more of its eight annual gatherings. But in 2001, it has cut rates between meetings twice because the economy has deteriorated so rapidly.
“Capital investment has continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen capital spending going forward,” said an
FOMC statement released along with the interest rate news.
“This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, threatens to keep the pace of economic activity unacceptably weak.”
The latest cut chops the funds rate from 5 percent. The rate is important because it guides the private-market rates banks charge on everything from home equity loans to credit cards, as well as the rates they pay out on certificates of deposit.
Because of the latest reduction, borrowers will be able to get even cheaper loans, but savers won’t earn as much on their CDs and money market account balances. The Fed also cut the less-important federal discount rate to 4 percent from 4.5 percent.
In their statement, officials reiterated their opinion that economic weakness is more of a threat than inflation right now. That suggests more rate cuts could come on May 15 or June 26 and 27 — the dates of the next two FOMC meetings.
The Fed has to fight rising unemployment, weak imports and other problems resulting, in part, from the unraveling of the spending and investment boom seen in late 1999 and early 2000, says Jim Coons, chief economist at Columbus, Ohio-based Huntington Bancshares Inc.
Corporations built numerous factories, hired tens of thousands of workers, and otherwise boosted production capacity to meet a surge in demand for goods and services from both companies and consumers. But falling stock prices and rising interest rates last year crimped customer demand, leaving businesses with employees and facilities they now have to eliminate.
“What’s going on in the economy is something that the Federal Reserve cannot prevent. It can avoid making it worse,” he says. “The Fed’s job in this environment is to lower interest rates to a level consistent with price stability given very weak economic growth.”
At the same time, the Fed has now cut rates by two full percentage points in just three and a half months. The cumulative economic stimulus from those moves could get growth back on track again soon. As a result, the long-term slide in interest rates seen since mid-2000 could be at or near an end.
“We’re not in a recession and we won’t be in one,” says Coons, adding that he’s split on whether another Fed cut is in the cards. “For the first time in this cycle, I think the Fed might be done. But I also think there’s a good chance they’ll do another half point at the May meeting and that that will be the end.”
— Posted: April 18, 2001