December 17, 2008 / 12:15 AM / 11 years ago

Fed cuts rates to record low

WASHINGTON (Reuters) - The U.S. Federal Reserve on Tuesday broke into uncharted territory as it chopped benchmark interest rates to as low as zero and pledged to use “all available tools” to turn back a deepening recession.

A trader in the Eurodollar options pit of the Chicago Board of Trade reacts shortly after the Federal Open Market Committee lowered short-term interest rates to between zero and 0.25 percent, in Chicago, December 16, 2008. REUTERS/Frank Polich

In a surprise and historic move, the Fed lowered its target for the interbank federal funds rate to a range of zero to 0.25 percent, a record low, from 1.0 percent, and said it was willing to keep rates low for an extended period.

“The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability,” the Fed said.

The U.S. economy is mired in a year-old recession that some fear could prove to be the worst since the Great Depression.

With the contraction worsening, inflation slowing, and no signs a housing market collapse is abating, officials felt a need to move decisively, and they signaled a willingness to buy potentially huge amounts of debt in an unconventional move to drive down private borrowing costs.

“The Fed has realized that there is one entity left to bring the financial system in line,” said Jessica Hoversen, fixed income market analyst at MF Global Research in Chicago. “It has to be the Atlas of the world to bear the weight of the financial system on its shoulder.”

The Fed’s announcement spurred a big rally in U.S. stocks, with the blue chip Dow Jones industrial average closing up 359 points, or 4.2 percent. Prices for U.S. government debt also shot higher, pushing yields to record lows.

The central bank’s unanimous decision undercut the U.S. dollar, which fell to a fresh 2-1/2 month low against the euro. The European Central Bank has held rates at 2.5 percent, the highest in the Group of Seven developed economies.

In addition to the rate cut, the Fed said it was prepared to expand a plan to purchase debt issued or guaranteed by government-sponsored mortgage agencies. It also said it was mulling purchases of longer-term U.S. Treasury debt and would consider other ways to tap its burgeoning balance sheet to support the economy.

The extraordinary measures the Fed is taking and a massive stimulus plan outlined by President-elect Barack Obama represent a form of shock therapy for the world’s biggest economy, which could in turn help growth elsewhere.

Financial markets had expected the Fed to lower rates by no more than three-quarters of a point.

OPENING FRESH FRONT IN CRISIS

“Weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time,” the Fed said, offering a policy commitment aimed at bringing long-term market-set interest rates down.

In the wake of the Fed’s action, interest rate futures prices were implying an unusually low level of rates through next year, with an end-2009 rate of just 0.69 percent.

A Reuters poll of 11 top Wall Street firms that deal directly with the Fed in the markets found none of them believed rates would begin rising before the second half of 2009 and several see rates on hold well into 2010.

U.S. officials have been unable to prevent the recession from deepening despite a series of initiatives to encourage lending by loss-scarred banks. The programs have pushed the Fed’s balance sheet to $2.2 trillion from $887 billion over the last three months. Some analysts think it could eventually top $3 trillion.

The rapid expansion amounts to a form of “quantitative easing”, a policy pursued by Japan earlier this decade to expand the supply and circulation of money after it was forced to lower rates to zero.

Japan, however, flooded the banking system with excess reserves to try to jump-start lending. In the Fed’s case, officials are trying to circumvent lending-wary banks and target specific markets where credit is jammed.

Slideshow (7 Images)

A senior Fed official, in an unprecedented conference call with reporters after the rate decision, said the U.S. central bank continues to expect a weak fourth quarter with economic growth picking up slowly over the the course of 2009.

Stark evidence of the economy’s mounting woes came in a report on December 5 that showed employers shed 533,000 jobs in November, the most in 34 years while the unemployment rate shot to a 15-year high of 6.7 percent.

Data released on Tuesday brought more downbeat news. Consumer prices plunged at a record pace for the second month in row in November and groundbreaking on new homes slumped to a new low.

Additional reporting by Alister Bull; editing by Tim Ahmann

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