Fed Cuts Interest Rate by Quarter Point

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WASHINGTON — The Federal Reserve, confronted by surging oil prices and a slumping housing market, cut a key interest rate by one-quarter of a percentage point Wednesday. But policymakers signaled that may be all the rate relief the economy needs right now.

The central bank lowered the federal funds rate to 4.5 percent, as expected. While financial markets had hoped for a clear sign of further cuts, the central bank indicated that rate cuts in September and October may be enough to stave off the threats of a recession.

Economists worry that growth will slow dramatically over the final three months of the year because of the housing slump, a credit crisis and record-high oil prices. The Fed, however, sounded a more upbeat tone.

The Fed also cited continued worries about inflation and said it believed that after the two rate cuts, the risks between weak growth and higher inflation were roughly balanced.

"The odds of another rate cut at the December meeting are substantially less than they were before this statement," said David Jones, chief economist at DMJ Advisors in Denver. Jones said he still expected one more rate cut to deal with a weak economy, but it probably would come at the Fed's January meeting.

Commercial banks responded to the Fed's decision by announcing a quarter-point cut to 7.5 percent in their prime lending rate, the benchmark rate for millions of consumer and business loans.

Wall Street sagged a bit immediately after the announcement, but quickly regained its footing and rose by more than 120 points in late afternoon trading.

In a brief statement explaining its decision, Fed Chairman Ben Bernanke and his colleagues said they now judge that "the upside risks to inflation roughly balance the downside risks to growth."

Stating that risks are now almost balanced was seen as a signal that the Fed believes further rate cuts may not be necessary.

The Fed's decision came on a 9-1 vote. Thomas Hoenig, president of the Kansas City regional Fed bank, dissented and preferred no change.

The Fed had lowered the funds rate by one-half of a percentage point at its Sept. 18 meeting.

The Fed also announced Wednesday it was cutting its discount rate, the interest it charges on direct loans it makes to banks, by a quarter-point, to 5 percent.

Commenting on the economy, the Fed was more positive than last month, when it expressed concerns about the toll the credit crisis would take on housing and the overall economy.

"Economic growth was solid in the third quarter and strains in financial markets have eased somewhat on balance," according to the Fed statement.

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

The Fed met on the same day the government announced that the overall economy grew at a stronger-than-expected 3.9 percent rate from July through September.

Many economists believe growth will dip to around 2 percent from October through December and may slow even further, to about 1 percent, in the first three months of 2008.

The Fed said the reading on core inflation, which excludes energy and food, had "improved modestly this year." But the central bank worried about what the recent increases in energy prices and other commodities might do to inflationary pressures.

The committee said "some inflation risks remain," a signal it will be hesitant to cut rates further because of concerns on inflation.

The Fed had pushed the federal funds rate up a record 17 consecutive times in quarter-point moves over two years. The last increase was in June 2006.

From that time until last month, the rate did not change. The Fed watched to see whether its credit tightening had the desired effect of slowing the economy enough to lessen inflationary pressures.

But the worst housing downturn in more than two decades has threatened the Fed's goal of slowing growth and containing inflation.

Economists worry that the credit crisis this summer will make home sales and prices fall even more, undermining consumer confidence and causing consumers to cut back on spending.

Bernanke, who took over as Fed chairman in February 2006 from Alan Greenspan, came under criticism in August when the Fed left rates unchanged and said inflation was the primary economic threat.

But two days after that meeting, when a severe credit crunch hit world financial markets, the Fed provided billions of dollars in cash to the U.S. financial system and cut the rate at which it makes direct loans to banks. Then, on Sept. 18, the Fed reduced the funds rate by one-half of a percentage point, which was more than expected.

Lyle Gramley, a former Fed board member and now an economist with Stanford Financial Group, put the chances of a recession at around 40 percent. He said the Fed's primary concern is what is happening in housing and how much of a spillover that will have on the overall economy.

"It is possible that the housing industry will take us over the edge into a recession," he said. Gramley noted that every housing downturn of the past 60 years, except for two, have triggered recessions.

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