Short-term interest rates will come down again, for the seventh time since September.
The Federal Reserve cut its target for the federal funds rate by a quarter-point, from 2.25 percent to 2 percent. The prime rate will fall by a quarter-point, from 5.25 percent to 5 percent. The move spells good news to people who borrow money on loans, such as home equity lines of credit, that are linked to the prime rate. It’s not such good news for savers who want to put their money in short-term certificates of deposit.
The rate-setting Federal Open Market Committee has been slashing rates to encourage consumers to borrow, and therefore stimulate the faltering economy. At the beginning of September, the federal funds rate stood at 5.25 percent; since then, the Fed has cut it by 3.25 percentage points. It has been an unusually rapid series of rate reductions, as the Fed has tried to catch up with the economic slowdown brought on by the housing slump.
“Recent information indicates that economic activity remains weak. Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation have risen in recent months. The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to moderate growth over time and mitigate risks to economic activity,” according to the Fed announcement.
The Federal Reserve knocked 25 basis points off a key interest rate.
This rate cut had been expected, with futures markets pricing in a 1-in-5 chance that the Fed would keep rates unchanged, and a 4-in-5 chance of a quarter-point cut. To the extent that anyone expected the Fed to keep rates unchanged, that sentiment stemmed from the inflation picture. As anyone who drives to the grocery store knows, prices for gasoline and food have been skyrocketing and threatening to eventually push up prices for everything.
Typically, rate cuts make inflation worse. That makes the case for holding short-term rates steady. But this isn’t a typical situation. Prices aren’t rising because the economy is booming; instead, they are rising despite an economic downturn.
“It’s a compromise between two equally persuasive arguments,” says Richard DeKaser, chief economist for National City Corp. “On the one hand, there’s an increasingly legitimate argument that inflation needs to be pre-empted more aggressively.” On the other hand, he says, “there is still risk to the economy in terms of weaker growth.”
