AP
Fed Cuts Rate to Help Ease Housing Slump
Wednesday October 31, 6:45 pm ET
By Jeannine Aversa, AP Economics Writer
Federal Reserve Cuts Interest Rate to Help Ease Strain of Housing Slump on Economy


WASHINGTON (AP) -- The Federal Reserve sliced an important interest rate Wednesday -- its second reduction in the last six weeks -- to help the economy survive the strains of a deepening housing slump that is likely to crimp growth in coming months.

Fed Chairman Ben Bernanke and all but one of his colleagues agreed to lower the federal funds rate by one-quarter percentage point to 4.50 percent at the end of a two-day meeting.

"The pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction," the Fed acknowledged in a statement explaining its action.

The funds rate affects many other interest rates charged to millions of individuals and businesses and is the Fed's most potent tool for influencing economic activity.

In response, commercial banks, including Bank of America, Wells Fargo and KeyCorp., announced that they were cutting their prime lending rate -- for certain credit cards, home equity lines of credit and other loans -- by a corresponding amount, to 7.50 percent.

The rationale behind the cuts is that the lower borrowing costs will induce people and businesses to boost spending, energizing economic activity.

Wall Street was cheered by the Fed action. The Dow Jones industrials jumped 137.54 points to close at 13,930.01.

The Fed policymakers supporting Wednesday's rate cut said the action -- along with a rate reduction in September -- was needed to "forestall some of the adverse effects on the broader economy" that might arise from the housing and credit troubles that have wreaked havoc on Wall Street over the past few months.

Fed policymakers indicated the two rate cuts ordered so far may be sufficient to help the economy make its way safely through the trouble spots.

They said the risks to the economy from inflation "roughly balance," or are equal to, the risks of a serious downturn in economic growth. Previously, the risks of a recession were seen as more of a threat to the country's economic health.

"The message: They are now done for the time being," said Lynn Reaser, chief economist at Bank of America's Investment Strategies Group. "They have taken out a significant insurance policy and now they believe they are fully covered against a recession risk -- at least for the near term," she said.

For now, Reaser and other economists think the Fed probably will leave the funds rate alone when its meets next on Dec. 11, the last session of the year.

The 9-1 decision to cut rates on Wednesday was opposed by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City. He preferred no change in the funds rate.

So far, the economy has shown amazing resilience to the housing and credit strains.

The economy grew at a brisk 3.9 percent pace in the summer, the fastest in 1 1/2 years, the government reported Wednesday. The impressive performance came even as the housing market sank deeper into the doldrums.

Fed policymakers, in their statement, said the economy turned in a "solid" performance in the third quarter. They also said that "strains from financial markets have eased somewhat on balance."

Even so, economic growth is expected to slow to a pace of around 2 percent or less in the current October-to-December period as the toll of the deteriorating housing market catches up with consumers and chills their spending.

As another bolstering move, the Fed also sliced its lending rate to banks by one-quarter percentage point on Wednesday. That was the third cut to that rate since mid-August.

Complicating the Fed's job to keep the economy and inflation on an even keel is surging oil prices. They soared to a record near $95 a barrel on Wednesday.

The Fed said "recent increases in energy and commodity prices, among other factors, have put renewed upward pressure on inflation." The Fed said that while some inflation barometers that exclude energy and food prices have improved modestly this year, some inflation risks remain. They pledged to "monitor inflation developments carefully."

If rising oil prices boost the cost of many other goods and services, then inflation could take off. At the same time, high energy prices could crimp consumer and business spending, putting another damper on overall economic activity.

Although the economy performed well in the third quarter, the housing slump deepened. It shaved more than a full percentage point off economic growth.

The meltdown in the mortgage market has made it harder for people to obtain financing to buy homes. That's aggravating problems in the housing market and leading to a mounting pileup of unsold homes. The housing slump is expected to drag on well into next year and foreclosures are expected to rise.

The Fed on Sept. 18 lowered its key interest rate for the first time in more than four years. It was seen as a pre-emptive strike to ensure housing and credit problems don't sink the economy. The Fed's aggressive action at that time prompted a rally on Wall Street, propelling the Dow Jones industrials up by nearly 336 points. It was the Dow's biggest one-day point jump in nearly five years.

Federal Reserve: http://www.federalreserve.gov/