Thu, May 17, 2001 page19

• US Fed cuts bank rate to new low

  Five half-point rate reductions since Jan. 3 constitute an unprecedented effort by Greenspan's Fed to kick-start an economy that grew in the past three quarters at the slowest pace in five years

  • BLOOMBERG
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  Federal Reserve policy makers lowered benchmark interest rates a half percentage point on Tuesday in the fifth such reduction this year and suggested another is possible to spark a rebound in US business investment.

  Fed Chairman Alan Greenspan and his colleagues on the Open Market Committee cut the target rate for overnight loans between banks to 4 percent, the lowest in seven years. Restrained purchases of equipment, possible weakness in consumer spending and slow global growth continue "to weigh on the economy," the Fed said in announcing the decision.

  The Fed's "focus remains firmly on a slumping manufacturing sector and slowing business investment," said Vincent Boberski, senior economist at Dain Rauscher Inc in Chicago. "This announcement opens the door to another half-point cut in rates." Minutes after the announcement, Bank of America Corp and Bank One Corp, the third- and fifth-largest US banks, said they would cut their prime rate by a half point to 7 percent by yesterday.

  

  Traders study a monitor on the floor of the New York Stock Exchange on Monday, as stocks dipped slightly in early trading as investors held back from making big bets before the US Federal Reserve's decision on interest rates. The Federal Reserve later announced a half-percentage point cut, though markets were mostly unimpressed.

  PHOTO: REUTERS

  That is likely to boost the economy, which stalled late last year and has recently begun to rebound.

  A rally in stocks fizzled on concerns the economy remains weak. Major stock indexes were little changed with the Dow Jones Industrial Average down 4 points and the NASDAQ Composite Index up 4 points.

  The US Treasury's 10-year note fell 1/2 point, pushing up its yield 8 basis points to 5.52 percent, on concern that the Fed could go too far and cause inflation to accelerate. In its statement, the Fed dismissed those worries, saying "inflation is expected to remain contained." Since the first of the year, the Fed has reduced its target rate 2 1/2 percentage points, the most aggressive period of rate- cutting ever by the Greenspan Fed. As they have with each rate reduction this year, central bankers warned the economy faces a risk of continued weakness.

  "The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending," the Fed said.

  Recent surveys show company executives plan to invest less this year than last on new equipment of the sort that allowed companies to double their productivity gains in the last five years. Spending on equipment and software, which grew more than 13 percent a year since 1995, fell in the last two quarters, Commerce Department figures show.

  "Business leaders that are buying capital equipment in general have to think there's going to be demand for their products," said Ray Bingham, chief executive of Cadence Design Systems Inc, the largest maker of software for designing computer chips. "When people are buying PCs and cell phones and investing in network infrastructure, then we'll know the demand picture has changed." Weak investment spending, "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," the central bank said on Tuesday.

  The Fed's Board of Governors also voted to cut the discount rate on loans to banks from the Fed system by a half percentage point to 3.5 percent. Although few banks borrow directly from the Fed to meet their cash reserve requirements, the central bank generally keeps the discount rate within a half point of the overnight bank rate.

  Five half-point rate reductions since Jan 3 constitute an unprecedented effort by Greenspan's Fed to kick-start an economy that grew in the past three quarters at the slowest pace in five years. Never before has Greenspan engineered so large a reduction in the overnight rate in so short a time, including the 1990-91 recession and its aftermath.

  In the 14 months from the start of the last recession in July 1990 until August 1991, the Fed lowered the overnight rate 2 3/4 points, to 5.5 percent from 8.25 percent. In the next 14 months, until September 1992, central bankers chopped 2 1/2 more points off the rate, taking it to 3 percent.

  Tuesday's cut in the overnight lending rate takes it to the lowest level since it was 3.75 percent in May 1994. Still, it might take six to nine months for the full effect of the Fed's rate reductions to work their way through the economy, economists said.

  Greenspan has repeatedly said the Fed had to alter its approach this year as the economy cooled more rapidly than anticipated. "We have developed, and of necessity will continue to develop, far more quicker response, presumably far more front- loading of response to reflect the changing environment in which we find ourselves," he told the US Congress in February.

  Tuesday's decision wasn't a surprise. Of 49 economists surveyed by Bloomberg News, 45 expected a half-point cut. The four others forecast a quarter-point reduction. Before the announcement, trading in fed funds futures contracts suggested little chance of any rate cut when policy makers next meet June 26-27 and less than a 50 percent probability of a quarter-point cut by October.

  The Fed last lowered rates in a surprise move April 18, when Greenspan conferred with his colleagues by telephone between regular FOMC meetings.

  The move sparked investor optimism and prompted stocks to climb. Since late March, yields on investment grade corporate bonds also have risen more than a half percentage point.

  There are other signs the economy is about to pick up. Gross domestic product expanded in the first quarter at a 2 percent annual rate, driven by gains in consumer spending and construction. That growth rate was twice that of the final three months of last year and almost twice as fast as economists had expected.

  Moreover, retail sales increased 0.8 percent in April after falling in March and February. And an index of consumer sentiment from the University of Michigan rose this month to its highest level since January.

  That could change if the jobless rate keeps rising, as is typically the case even after the economy starts to improve. The US economy lost 223,000 jobs in April, more than at any time in the last decade and unemployment rose to 4.5 percent, the highest in 2 1/2 years.

  Consumer optimism is "mostly an employment-related phenomenon," said David Wyss, an economist at Standard & Poor's in New York. That's important because consumer spending accounts for two-thirds of US gross domestic product. If Americans grow more pessimistic, sales may falter again. May's "employment number is the key," Wyss said.

  Manufacturing also remains in a slump, though it accounts for only about 20 percent of GDP. Industrial production fell in April for the seventh straight month, and the amount of industrial capacity in use fell to the lowest point since the end of the last recession.

  The decline in manufacturing production may reverse soon. The US Commerce Department reported a gain in new factory orders for March, which was mirrored in the latest survey by the National Association for Purchasing Management.

  And inventories, which had grown too large, declined in the first quarter for the first time in almost 10 years. "There's no better excuse for increasing production," said Neal Soss, chief economist at Credit Suisse First Boston Inc in New York.

  Auto inventories, in particular, have come back to levels that match demand, Soss said.
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