Skip to content
Link copied to clipboard

Lowest ever benchmark lending rate

As consumer prices and housing starts plunged, the Fed boldly slashed rates to fight recession.

WASHINGTON - The Federal Reserve slashed its benchmark lending rate yesterday at least three-quarters of a percentage point to a record low as it struggled to right the economy amid a deepening recession.

Fresh signs of the recession arrived yesterday as the Labor Department reported a record plunge in consumer prices in November - reflecting the massive drop in energy prices spurred by the economic slowdown - and housing starts dropped 18.9 percent from October to November.

But there was a bright spot: Stock markets rose sharply yesterday. The Dow Jones industrial average was up more than 4 percent, and the S&P 500 and Nasdaq each rose more than 5 percent. The Fed's action was bold enough to convince investors that it would do what was necessary to combat the recession.

The extraordinary Fed action, which brings the overnight lending rate between banks down to a target range of zero to one-quarter of a percentage point, was larger than expected. Also, the Fed usually targets a specific rate.

In theory, it should bring down the cost of borrowing for consumers and businesses, because the prime rate, which banks charge their best customers, moves in tandem with the federal funds rate.

The prime rate typically influences a wide range of rates for car loans, student loans, credit cards and other instruments of debt. With yesterday's cut, the prime rate is expected to fall to 3 percent to 3.25 percent from 4 percent.

Even so, banks simply are not lending to most consumers and businesses in this climate. Weak financial institutions continue to hoard cash and build their balance sheets, with little appetite for risk in new loans. That is worsening the downturn, especially because it hurts consumers, who drive almost two-thirds of U.S. economic activity.

In a statement announcing its rate cut, the Fed's policymaking Open Market Committee said that, because "the outlook for economic activity has weakened further . . . the Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability."

It vowed to stimulate the economy through interest-rate and monetary policy and by buying federal agency debt and mortgage-backed securities. It said it was weighing whether to buy longer-term Treasury debt.

The Fed also said it would tap its Term Asset-Backed Securities Loan Facility to "facilitate the extension of credit to households and small businesses."

Expect the Fed to take additional aggressive steps in the weeks and months ahead, said Mark Zandi, the chief economist for forecaster Moody's, in West Chester.

"The Fed has the ability to purchase just about anything," he said, "and they will do so if they think it will help unfreeze credit markets."

Plunging oil and gasoline prices were behind the month's steep 1.7 percent drop in consumer prices, the Labor Department reported. That helped energy-intensive companies such as airlines and trucking. Falling prices also give consumers buying power.

Not all the news was good on the inflation front, however. The monthly drop was the largest since the government began compiling inflation records in 1947, and that underscores the magnitude of the current downturn.

It also highlights the possibility of deflation, a broad decline in prices that erodes value.

Also, U.S. housing starts fell 18.9 percent in November, according to the Commerce Department. On a year-over-year basis, housing starts are off 47 percent since November 2007.

"This may be the worst housing report ever. Not only did housing starts, housing permits, and single-family starts plunge to all-time lows, [but also] the double-digit drop in permits points to further two-digit drops in starts in December and January," Patrick Newport, an economist with forecaster IHS Global Insight Inc., of Lexington, Mass., said in a research note. Federal housing data began being collected in 1947.

While that is bad news for the construction sector and home builders, it indicates good news longer term for the nationwide housing market because it means there is less inventory being built on top of what is viewed as a glut.

Rising home foreclosures and the difficulty in obtaining loans amid the credit freeze, Newport said, are likely to depress the market for new housing units well into next year.

In the Fed's Words

From yesterday's Federal Open Market Committee statement on interest rates and the economy:

Since the committee's last meeting, labor market conditions have deteriorated, and . . . consumer spending, business investment and industrial output have declined.

Meanwhile, inflationary pressures have diminished. The committee expects inflation to moderate further.

The Federal Reserve will employ all available tools to promote resumption of sustainable economic growth.

In particular, the committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.