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Fed Cuts Key Interest Rate By Quarter Point; Stocks Fall

Federal Reserve Board Chairman, Ben Bernanke, speaks at the CATO Institute's annual Monetary Conference in Washington in this Nov. 14, 2007 file photo. Twice the Fed has cut rates this year and officials suggested in October that might be enough for the year to help the economy survive all that stress. Then the problems snowballed, leading Bernanke to signal one more cut might be needed. Analysts expect the Fed to trim its key rate, now at 4.5 percent, by one-quarter of a percentage point at their next meeting . AP Photo/Caleb Jones, File)
Federal Reserve Board Chairman, Ben Bernanke, speaks at the CATO Institute's annual Monetary Conference in Washington in this Nov. 14, 2007 file photo. Twice the Fed has cut rates this year and officials suggested in October that might be enough for the year to help the economy survive all that stress. Then the problems snowballed, leading Bernanke to signal one more cut might be needed. Analysts expect the Fed to trim its key rate, now at 4.5 percent, by one-quarter of a percentage point at their next meeting . AP Photo/Caleb Jones, File) (Caleb Jones - AP)

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By Neil Irwin
Washington Post Staff Writer
Wednesday, December 12, 2007

The Federal Reserve cut a short-term interest rate yesterday to try to keep problems in the housing and mortgage markets from dragging the nation into recession, but Wall Street judged the move as too timid and financial markets tanked.

The Fed's policymaking committee cut the federal funds rate, at which banks make overnight loans to each other, by a quarter percentage point, to 4.25 percent. The third rate cut this year is likely to trickle through to interest rates on credit cards, business loans and some adjustable-rate mortgages.

But investors had hoped for a half-point cut, or at least a clearer signal that the central bank will cut rates again in the future, and stocks plummeted. The Dow Jones industrial average closed down 294 points for the day, a 2.1 percent drop.

"Wall Street wanted a decisive move and they didn't get it," said Robert Dye, a senior economist at PNC Financial Services Group. Money poured into safe U.S. government bonds -- two-year Treasurys had their biggest rise in three years -- on increased fears of a recession.

In a statement accompanying the rate cut, the Fed policymakers acknowledged that the economy is getting weaker. "Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending," said the release from the Federal Open Market Committee.

But the committee did not explicitly change its view of how the risk of inflation is balanced against that of slower growth, which would have indicated a strong likelihood that it will cut rates again at its Jan. 30 meeting.

It appeared more inclined to keep its options open. Fed leaders, based on their recent speeches, view this to be a unique and uncertain time for the economy and have said they want to be as flexible as possible.

Chairman Ben S. Bernanke is "slowly but surely taking interest rates down," said Robbert Van Batenburg, head of research at Louis Capital Markets. "The message he's trying to convey to the markets is that he is not overreacting."

Wall Street was also disappointed that the Fed did not take any action to ease the problem of banks being reluctant to part with their cash -- a shortage of liquidity in the financial system that has made certain kinds of borrowing more expensive despite the rate cuts.

Leaders of the central bank have been working on ways to improve liquidity, according to a recent speech by Vice Chairman Donald L. Kohn, but solutions are tricky and can have unintended consequences. The central bank could announce such moves down the road despite not disclosing any in its announcement yesterday.

"It's clear that they are exploring their options," said Peter Hooper, chief economist of Deutsche Bank. "They want to do something to help ease the tightening of financial conditions."

The decision was not unanimous. Eric S. Rosengren, president of the Federal Reserve Bank of Boston, voted to cut the federal funds rate by a half-point. At the previous meeting, on Oct. 31, there was also a dissenter, Thomas M. Hoenig of Kansas City, who favored no rate cut at all.


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© 2007 The Washington Post Company

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