Fed Lowers Rate to 2%, Seventh Cut Since Credit Squeeze Began

By Craig Torres

April 30 (Bloomberg) -- The Federal Reserve lowered its main interest rate by a quarter of a percentage point to 2 percent, the seventh cut since the onset of a global credit squeeze that's eroded economic growth.

``The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time,'' the Federal Open Market Committee said in a statement after meeting today in Washington. ``The committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.''

While a nine-month contraction in credit and soaring fuel prices have pushed the economy to the edge of recession, confidence has begun to return to financial markets. Inflation expectations are also picking up, driven by near record prices for oil and higher food expenses.

``Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters,'' Chairman Ben S. Bernanke and his colleagues said in the statement.

Oil prices marched to another record high of $119.93 a barrel on April 28. The Fed said indicators of inflation expectations have risen. ``The committee expects inflation to moderate in coming quarters, reflecting the projected leveling- out of energy and other commodity prices and an easing of pressures on resource utilization,'' the Fed added.

``It will be necessary to continue to monitor inflation developments carefully,'' the Fed said. Uncertainty about prices ``remains high.''

At the same time, the economy is faltering. Hours before the Fed decision, the Commerce Department reported that gross domestic product increased at an annual pace of 0.6 percent last quarter. Spending by households, the biggest part of the economy, grew at the slowest pace since 2001, when the U.S. economy was in a recession.

Discount Rate

The Fed Board of Governors also voted to lower the discount rate, the cost of direct loans from the central bank, to 2.25 percent. Officials reduced the normal 1-point spread over the federal funds rate in August to a half point to ease liquidity constraints. They further narrowed the difference on March 16, in the first weekend emergency move since 1979.

Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser dissented from today's decision, preferring no change. They also objected to last month's reduction.

Central bankers have reduced the interbank lending rate 2.25 percentage points in 2008 with a series of aggressive rate actions, including two three-quarter point cuts and one half- point cut prior to today's move. In addition, the Fed resorted to an emergency authority in March and opened a direct loan window for investment banks.

Creaking Into Life

The actions have reduced risk premiums for financial firms, and stock prices have climbed since the previous Fed meeting on March 18.

The Standard & Poor's 500 Index has rallied since Fed officials last met. Yields on five-year obligations of Fannie Mae, the largest U.S. mortgage company, have fallen to 0.56 percentage points over Treasury notes of similar maturity, down from 0.90 percentage point.

``Credit markets seem to have stabilized in most areas,'' Brian Sack, senior economist at Macroeconomic Advisers LLC in Washington, said before the meeting. ``We believe that the Federal Open Market Committee is ready to slow the pace of its actions.''

The world's biggest financial companies have posted at least $312 billion in writedowns and credit losses tied to U.S. mortgage markets as of April 28. U.S. foreclosure filings more than doubled in the first quarter as payments rose for subprime adjustable mortgages. One in every 194 U.S. households, or 650,000 properties, were in some stage of foreclosure during the quarter, according to Irvine, California-based RealtyTrac Inc., a vendor of data.

Hastening Inflation

While easing borrowing constraints, the central bank has also pushed money market yields below inflation, giving consumers an incentive to spend or take on more risk in their investments to earn a return. The Fed's preferred inflation barometer, the personal consumption expenditures price index, minus food and energy, rose at a 2.2 percent annualized rate in the first quarter. Six-month Treasury bills yield 1.7 percent.

Five-year-ahead inflation expectations measured by the Reuters/University of Michigan survey rose to 3.2 percent April, the highest level since October 2005.

``If they do lose credibility as an inflation-fighting institution, they will find it much harder to do anything,'' James Hamilton, an economist at the University of California, San Diego, said in a television interview before the meeting. ``It is a slope you do not want to start sliding down, and I am afraid the Fed has already started.''

Meanwhile, housing markets are still in a slump. Home prices in 20 U.S. cities fell in February by the most on record. The S&P/Case-Shiller home-price index dropped 12.7 percent from the same month a year earlier, the most since the figures were first published in 2001. Builders broke ground on 947,000 new homes at an annual rate in March, the fewest since March 1991.