Fed slashes rates another half-percent

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For the fifth time in five months, Federal Reserve Board officials slashed interest rates by one-half a percentage point, saying that weakness in business spending, falling stock prices and uncertainty about the future continue to threaten economic growth.

The May 15 move lowers the key federal funds rate to 4 percent from 4.5 percent and the federal discount rate to 3.5 percent from 4 percent. The funds rate, which guides the private-market rates banks charge on everything from home equity lines of credit to auto loans and what they pay out on certificates of deposit and money market accounts, is now at its lowest level in seven years.

“A significant reduction in excess inventories seems well advanced. Consumption and housing expenditures have held up reasonably well, though activity in these areas has flattened recently,” said a
statement released by the Federal Open Market Committee, which sets interest rate policy for the broader Fed.

“Investment in capital equipment, however, has continued to decline. The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward.

“This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy.”

While FOMC members normally dole out rate cuts at a leisurely pace, they have been particularly generous to consumers in 2001. The Fed hasn’t lowered rates by 250 basis points, as they have so far this year, in so short a time during Chairman Alan Greenspan’s 14-year tenure. Two of those rate cuts came between regularly scheduled meetings, too.

Policymakers have said they acted with such haste and magnitude because the economy weakened sharply at the end of last year and early this year. They’ve kept on cutting because things haven’t improved much to date.

But even though employment remains weak and corporate spending and investment continues to stagnate, consumer spending hasn’t fallen off a cliff. In fact, sales of everything from houses to clothes have held up in the face of layoffs and plant closings. That has kept a floor under the economy.

Because the economy hasn’t slipped into recession and appears to have reached a bottom, some market watchers think the Fed won’t continue to cut as aggressively over the next couple of months as it has the past few.

The next FOMC meeting will be a two-day affair on June 26 and 27, and officials may cut rates by just 25 basis points. At the same time, the Fed reiterated a statement that the risk of further economic weakness outweighs the risk of inflation accelerating. That means more rate cuts are likely.

No matter what happens, though, interest rates are probably much nearer to a trough than a peak.

— Posted: May 15, 2001