Fed Cuts Interest Rate By Half Point to 1 Percent

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The Federal Reserve cut interest rates for the second time in three weeks, slashing its federal funds target by one-half of a percentage point to 1 percent.

"The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures," the Fed said in explaining its decision.

"Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports," the Fed said. "Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."

The Fed said rate cuts in the U.S. and other countries and "steps to strengthen financial systems ... should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain."

Wednesday's cut, which had been expected by the markets, came amid the current financial turmoil and fears that there might be a prolonged recession. Partly in anticipation that the Fed would lower rates, stock markets rallied Tuesday, with the Dow Jones industrial average soaring nearly 11 percent, or 889 points. On Wednesday, the Dow closed down 74 points at 8990.

On Oct. 8, Fed policymakers cut the fed funds rate by a half point in coordination with several other central banks around the world.

"The markets are expecting they'll keep going and cut them further, perhaps" to 0.5 percent, by year's end, David Wessel, economics editor at The Wall Street Journal, told NPR's Renee Montagne earlier Wednesday.

Indeed, the Fed hinted at further cuts, saying it "will act as needed to promote sustainable economic growth and price stability."

The Fed is trying to offset the credit crunch that has frozen lending. The previous rate cut helped some, but not enough, Wessel said.

General Motors Corp. said Wednesday that its third-quarter sales in North America plunged nearly 19 percent and global sales fell 11.4 percent as demand for GM vehicles weakened amid growing economic pressures.

However, the Commerce Department said orders for durable goods, such as cars, appliances and machinery, rose 0.8 percent in September, the largest increase in three months. Analysts had expected a decline.

On Tuesday, the Conference Board said its consumer confidence index had plunged to the lowest level in its 41-year history in the wake of this month's financial meltdown, the sharp drop in home prices and increasing job losses.

The last time interest rates were this low, under former Fed Chairman Alan Greenspan, they sparked excessive borrowing. "I think the Fed worries about that," Wessel said. "The conventional wisdom inside the Fed now is with the benefit of hindsight they kept rates too low for too long during the Greenspan years and that created this housing bubble. ... And they'd like to avoid that again.

"But you don't want to fight the last war, and with the economy suffering so much, with so much at stake, they are doing the only thing they can do, which is administer this low-interest-rate medicine," Wessel said.

The challenge for the Fed will be to decide when to begin raising rates, once the economy improves. For now, analysts are estimating the economy contracted by about 0.7 percent during the third quarter and will shrink even more during the fourth quarter and the first three months of 2009. They also see unemployment eventually rising to 7.5 percent or 8 percent, from last month's 6.1 percent.

Even when the economy comes out of recession, it's expected to grow very slowly.

"What we are seeing now is the ripple effects of the credit crunch spreading out throughout the economy," not just in the U.S. but worldwide, "so our export markets are going to be lousy as well," Wessel said.

The government's bailout of the financial system will take time to have its effect, he says. "The medicine will not make the patient better until the banks feel healthier and begin to lend again, and we're clearly not there yet."

From NPR staff and wire reports.

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