Fed banks split over discount rate cut: minutes

WASHINGTON (Reuters) - The regional U.S. Federal Reserve banks were split on the appropriate cut in the discount rate ahead of the September 18 Fed policy meeting amid differing views about how much tighter credit would hurt the economy.

Minutes of the Washington-based Fed Board, which must approve changes to the discount rate, showed that four banks sought just a quarter-percentage-point cut in the rate to 5.5 percent, while seven banks wanted a half-point cut to 5.25 percent. The Philadelphia Fed sought no change.

The Fed Board approved a half-point cut in the discount rate, its second in just over a month, on September 18, the same day the policy-setting Federal Open Market Committee cut the federal funds target rate by a half point to 4.75 percent.

At a September 17 meeting, the Fed board refrained from changing the discount rate, which governs the interest the Fed charges for direct emergency loans to banks.

"Federal Reserve Bank directors in favor of a 50-basis-point reduction cited concerns about increased downside risks to the real economy," the board said in the September 17 minutes, adding:

"Most directors believed that the recent tightening of credit conditions appeared likely to have contractionary effects on the economy ... and that these effects could be significant, partly by intensifying the correction in the housing sector."

Some of these directors also noted that August's weak employment report, which at the time showed a 4,000 fall in nonfarm payrolls, "was perhaps an early sign for a slowdown".

The August payrolls, however were revised in early October to show an increase of 89,000 jobs for that month.

The Fed Board's September 17 minutes said those bank directors favoring a 25 basis-point cut "also expressed concern about the near-term prospects for economic activity and they generally agreed that inflation risks had diminished a little and risks to growth had increased."

But they viewed a quarter-point reduction to 5.5 percent as "the appropriate adjustment to the stance of monetary policy at this time."

Fed board minutes from an August 16 meeting also showed that the St. Louis Fed bank had sought a quarter-point reduction in the discount rate as early as August 9, as financial market turmoil was intensifying in response to a credit squeeze.

The board at the August 16 meeting approved a half-point cut in the discount rate to 5.75 percent, responding to requests for a half-point cut made the same day by the New York and San Francisco Fed banks.

The market-calming decision was announced on August 17 to boost liquidity to the banking system and accompanied the FOMC's announcement of a policy shift and a pledge to take action to shield the broader economy from housing and credit market fallout.

The cut was followed by a campaign by the Treasury and Fed to encourage more banks to borrow from the Fed's discount window, which has typically been seen as a lender of last resort for troubled banks.