Fed cuts rates by quarter point

WASHINGTON (Reuters) - The Federal Reserve cut interest rates by a quarter-percentage point on Wednesday to buffer the economy from a housing downturn, but suggested further rate reductions were far from a sure bet.

The decision by the central bank's Federal Open Market Committee to lower the overnight federal funds rate to 4.5 percent -- a move that followed a more aggressive half-point cut last month -- was widely expected.

But the Fed offered a bit of a surprise by saying the risk of inflation was about equal with downside risks to growth.

That statement, coupled with a dissent from Kansas City Federal Reserve Bank President Thomas Hoenig, who favored holding rates steady, threw cold water on expectations that additional reductions in borrowing costs are in store.

"The Fed has no inclination to cut rates further unless the economic data suggest otherwise. Hence, barring another financial shock, the economic data will have to weaken for Fed easing to come back on the table," said Joseph LaVorgna, chief U.S. economist for Deutsche Bank.

U.S. Treasury debt prices fell and stocks initially dropped as traders saw the Fed's statement suggesting a lower likelihood of further rate reductions.

Stock prices, however, later turned around and the blue- chip Dow Jones industrial average closed up 137.54 points, while the dollar hit a record low against the euro.

U.S. interest-rate futures contracts implied only a 42 percent chance the Fed will lower rates again at its next meeting in December, down from 64 percent overnight.

In announcing its decision, the U.S. central bank said its actions should put the economy on better footing and help it weather the housing slump and related credit market woes.

"The pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction," the Fed said. But it said its rate cuts "should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time."

The decision by the Fed to lower the federal funds rate, which governs overnight borrowing between banks, led major banks to lower the prime rate they charge on loans to their best customers. It could also lead to lower rates on credit cards and auto loans for consumers; most mortgage rates, however, are tied to long-term rates set by the markets.

TENSION IN THE RANKS

In its statement, the central bank cautioned that it has not put to bed worries about price pressures, a point underscored by Hoenig's dissent.

"Recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation," the Fed said. "In this context, the committee judges that some inflation risks remain.

After this (rate) action, "the upside risks to inflation roughly balance the downside risks to growth," it added.

A Reuters poll of 20 top bond trading firms that deal directly with the Fed in the markets found seven believe the rate-cutting cycle is now over. The median forecast from the firms was that rates would eventually bottom out one-quarter point lower at 4.25 percent.

More details on the Fed's thinking are likely to emerge on November 8 when Fed Chairman Ben Bernanke testifies before the congressional Joint Economic Committee.

In addition to lowering the federal funds rate, the Fed's main economic lever, the central bank on Wednesday also trimmed the discount rate by a quarter-percentage point to 5 percent. The discount rate governs loans the Fed makes directly to banks having trouble finding the cash they need in the market.

Credit markets, which were roiled in August as concerns mounted over rising delinquencies in the U.S. mortgage market, have regained some stability since the Fed lowered rates by a half-percentage point on September 18.

As policy-makers convened on Wednesday, a government report showed that growth in the third quarter was considerably stronger than most economists expected.

U.S. gross domestic product, which measures total production within the country's borders, grew at an annual rate of 3.9 percent in the July-September period -- the strongest advance since the first quarter of 2006.

A separate report showed private-sector employers added more jobs than expected in October, implying more underlying strength to the economy than previously thought.

(Additional reporting by Glenn Somerville)