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Fri, Nov 02, 2007 - Page 10 News List

Fed trims short-term rates to stimulate economy

DOUBLED-EDGED SWORD While the new rate cut may lower borrowing costs for consumers, it also sent the dollar plunging, which could affect the cost of imports


The US Federal Reserve cut short-term interest rates on Wednesday in a widely anticipated move, saying it had acted because of concerns economic growth would likely cool in coming months.

The Fed trimmed its federal funds interest rate by a quarter of a percentage point to 4.5 percent. Wall Street shares rallied in the wake of the announcement, propelling the Dow Jones Industrial Average stock index to a close of 13,930.01 points.

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

The Fed slashed borrowing costs on Sept. 18 by a more dramatic half a percentage point, but the housing slump -- one of the worst in decades -- has shown no sign of improvement.

"The concerns over housing and credit seem to be dominant for most of the FOMC [Federal Open Market Committee] and their evaluation today," said Carl Tannenbaum, chief economist at ABN AMRO North America, Inc.

The Fed said policymakers, led by Fed Chairman Ben Bernanke, had reduced rates in an effort to keep the world's largest economy growing at a "moderate" pace.

The decision was not unanimous, however, as Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, voted to keep the fed funds rate pegged at 4.75 percent.

Hoenig was heavily outvoted by nine other policymakers, who all wanted to cut borrowing costs.

Aside from the distressed housing market, the Fed's second rate cut in as many months will also offer some relief to ailing credit markets, which have tightened as commercial banks have endured hefty losses linked to mortgage-backed securities.

"This action will help to stabilize the financial markets," said Brian Bethune, a US economist at Global Insight.

The global investment bank Merrill Lynch announced one of the biggest losses in its history last week, revealing it had been forced to write-down almost US$8 billion, mainly owing to soured bets on mortgage securities.

"There are still sectors of the credit markets that are not functioning very well. Very simply stated, if capital is not flowing, then firms are more hesitant to make investments," Tannenbaum said.

The fresh rate cut is also likely to be appreciated by consumers who will benefit from lower borrowing costs, but it dealt a fresh blow to an already weakened dollar.

The euro leapt to a record high of US$1.4504 in the aftermath of the Fed's announcement. The dollar's decline on foreign exchange markets makes foreign goods and products, particularly oil, more expensive for Americans to purchase.

The Fed cited concerns about rising energy and commodity prices, saying they could renew inflationary risks, but economists said housing and credit worries outweigh inflation risks for now.

Although US economic growth has been robust in recent months, economists fear growth could slow markedly in coming months, largely because of the widespread housing downturn and mounting home foreclosures.

"As we struggle to find a new equilibrium for home prices, are consumers who are seeing the values of their properties diminish going to adjust their spending patterns?" Tannenbaum said.

Sales of existing homes and apartments dived 8 percent in September to a seasonally adjusted rate of 5.04 million properties. Sales and home prices have plummeted as a glut of unsold properties has flooded the market.

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