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US Federal Reserve responds to credit crisis with 0.5% cut in its key interest rate to 4.75%; Dow rises 336 points
By Finfacts Team
Sep 19, 2007, 01:37

President George W. Bush announces the nomination of Ben Bernanke as Chairman of the Federal Reserve, replacing Alan Greenspan upon his retirement in January 2006. The announcement came Monday, Oct. 24, 2005, in the Oval Office.

The US Federal Reserve responded aggressively on Tuesday to the fear that the credit crunch could trigger a US recession, with a surprise half-percentage-point cut in interest rates, despite fears that it would give the appearance that it was bailing out investors.

The cut, which was beyond what most analysts had expected, suggests that Chairman Ben Bernanke, confronted with the prospect of damage to the economy from the credit turmoil that has dominated the market for more than a month, opted for a riskier move rather than be blamed later for timidity. With reports of rising home foreclosures, the earlier forecasts of Bernanke and the majority of Wall Street that the subprime mortgage crisis would be contained, had been dashed in early August when the credit markets seized up on a global basis.

The Fed cut its target for the federal-funds rate, charged on overnight loans between banks, to 4.75% from 5.25%. It also cut its discount rate, charged on direct loans to banks, by the same amount, to 5.25%.

The Fed action triggered a rally on the Wall Street. The Dow Jones Industrial Average, which was up 70 points before the decision was announced, jumped 335.97 points, or 2.5%, to 13739.39, its biggest percentage rise since 2003.

In a reaction that the rate move could boost inflationary pressures, the US dollar fell, long-term Treasury bond yields rose, and oil and gold prices also jumped.

In the  statement of the rate-setting Federal Open Market Committee (FOMC), the Fed did not provide any signal on its next likely move. "Some inflation risks remain," it said. But "developments in financial markets ... have increased the uncertainty surrounding the economic outlook." However, the Markets do put high odds on a quarter-point cut at the Fed's next meeting, on Oct. 30.

Dr. Peter Morici who is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission commented:

Clearly Bernanke sees weakness in credit markets affecting the broader economy. Cutting both the fed funds rate and discount rate by 50 basis points is strong medicine, especially considering Bernanke's conservative inclinations.

Bernanke is much more inclined to errors of omission than errors of commission. Information from the regional Federal Reserve Banks must indicate that turmoil in credit markets is strongly affecting business spending and taking the economy to the brink of recession.

My bet is that this move, along with other rate cuts later, as needed, will avert a recession.

FOMC Statement