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Federal Reserve cuts interest rates to 2 percent

The Federal Reserve cut the Federal funds rate a quarter-point to 2 percent today, the lowest since 2004.  The Fed indicated that its dramatic monetary easing the last 7 months was coming to an end.  The Federal funds rate was 5.25% last September and has been lowered aggressively to offset the housing and credit crises and the economic downturn.

  The Feds rate cuts and emergency actions have ameliorated the impact of the global credit crunch and helped to restore liquidity and confidence to the financial markets.  The stock market is 9% above the low it established in March as investment bank Bear Stearns stock collapsed.

  The Federal Reserve moved to a neutral outlook shifting to a less aggressive policy.  They indicated there are still continued fears of a recession and the Fed could lower rates in the future.  The low rates have fueled inflation causing record prices in food and energy and weakened the dollar against foreign currencies.

  Prior to the rate announcement the Commerce Department announced that gross domestic product (GDP) grew 0.6% in the first quarter, the same amount that GDP grew in the fourth quarter of 2007.  The last two quarters have shown extremely weak growth but and avoided the technical definition of a recession as two consecutive quarters of negative growth.

  The Fed stated, “Household and business spending has been subdued and labor markets have softened further.  Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.”  The Fed said it “expects inflation to moderate in coming quarters.”

  The labor department said that employment compensation rose 0.7% in the first quarter, the smallest increase in two years.   A separate report showed that consumer spending was growing at the slowest rate since 2001 as stagnant wages and lower home prices have people feeling less wealthy.

Federal Reserve Ready To Lower Interest Rates

The Federal Reserve began the two day Federal Open Market Committee (FOMC) meeting that will culminate in an interest rate decision tomorrow.    Economic forecasters predict that the Fed will reduce the Fed funds rate by a quarter-point to 2.0%.  The rate was as high as 5.25% last September. 

  It is likely the Fed will pause after this meeting to determine the effects of its prior rate reductions and analyze their impact.  Pressure is building to end the easing in the form of record high commodity prices in food and energy.  The dollar has weakened to record low levels and outside the housing sector the economy is not as weak as expected.  Stock market prices have increased lately and indications are the credit crisis is improving.  Also consider the $152 billion tax rebate stimulus and the lagged effect of 3% of prior easing. 

  Recently weakness in the housing market has been offset by strength in the job market.  The Labor Department reported that claims for unemployment benefits fell by 33,000 to 342,000.  Forecasters had been expecting a rise of 3,000.    The Case-Shiller home price index indicated home prices fell by 12.7 percent in February compared to a year earlier.  The index dropped 10.7 percent in January and 9.1 percent in December.  The cities with the largest annual price declines were Las Vegas 22.8 percent, Miami 21.7 percent  and Phoenix down 19 percent.

  Robert Shiller, the Yale professor who invented the index, said that home prices could fall more than the 30 percent drop of the 1930s depression.  Housing inventory has soared to record levels as home mortgage financing has restricted and foreclosures add to the supply.  Over one million units are still under construction and experts expect the inventory overhang to persist and continue to apply downward pressure on prices.

  For a chart of home prices the last 12 years please follow this Case-Shiller and OFHEO Indices link.