Federal Reserve & Interest Rates

In a move that underscores how serious the current financial crisis is effecting the global economy, the leading central banks of the world joined together in a coordinated monetary policy initiative.  The unprecedented joint effort to cut interest rates by half a percent was soon followed by other central banks as economies around the world attempt to stop the bleeding from the worst financial crisis since the Great Depression.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. 

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

The European Central Bank up until now had been steadfast in their resolve in avoiding interest rate cuts in an effort to promote price stability.  The recent slide in oil that has accompanied the renewed strength in the dollar has played a large part in their reversal of course.

Global stock markets have taken a pounding in the last week with a number of exchanges halting trading.  At this point a global recession seems unavoidable.  Although the U.S. has avoided negative economic growth thus far, other countries haven’t been so lucky as the financial troubles in this country have quickly spread around the globe.

The $700 billion financial rescue package approved by Congress will take time to work it’s way through the banking system but until that happens credit markets will remain practically frozen.  Until lending can resume at normal levels, the housing market is unlikely to improve anytime soon.

The latest setback for Wall Street has also had a big impact on consumer confidence levels and we can expect Americans to tighten their belts further.  Consumer spending levels are expected to take a sharp hit during the holiday shopping season with many retailers cutting their earnings forecasts for the fourth quarter.

Whether or not this latest move by world’s central banks can stem the tide of financial collapse remains to be seen but the rest of the world is starting to realize that they are going to have to work together in order to get through this mess.

This afternoon, the Federal Reserve announced the seventh rate cut since it began slashing interest rates last September.  It lowered both the benchmark federal funds rate as well as the discount rate by 25 basis points to 2% and 2.25% respectively.

The Commerce Department also released economic data which showed that GDP had slowed in the first quarter to a 0.6% annual growth rate.  In a press release, the Fed acknowledged the worsening of the economy despite it’s recent efforts.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. 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.

In a sign that the credit crisis may be easing somewhat and that inflation remains a concern, it was the smallest rate cut the Fed instituted this year.  While core inflation has slowed recently, energy and food prices have continued to skyrocket.

Some economists have been critical of the Fed for lowering interest rates to the point that short term Treasury yields are now below the rate of inflation which causes a disincentive to saving.  Still, many analysts believe that this will probably be the last rate cut we see for some time unless credit conditions worsen again.

The Fed will most likely wait and see what impact the economic stimulus package has on consumer spending before making any further moves.  Rebate check began going out to households earlier this week.

The Euro has begun to lose a small amount of value against the dollar after its record high of $1.6019 earlier this week.  The euro traded at $1.5685 late yesterday.

The dollar gained a small bit of value against Japanese currency.  The dollar is worth 104.63 yen.  This is up from the value of 104.22 yen earlier this week.

The British pound is now trading at 1.9763 dollars.  Swiss francs are trading at 1.0349 dollars.

The Euro has remained strong against the dollar for several years, with its strength increasing during the US rate cuts made by the Federal Reserve.  Since September of last year, the US Federal Open Market Committee has reduced the discount rate and the federal funds rate repeatedly.  This has opened the door for inflation problems and weakened the strength of the dollar.

The European Central Bank has primarily focused on keeping inflation under control as much as possible, and has chosen to keep their interest rates the same.  The primary focus of the US Federal Reserve Board has been to stimulate economic growth and increase liquidity in the markets to combat recession and a major credit crunch.

Experts speculate that the Federal Reserve will make at least one more modest rate cut in light of the inflation problem in the US.  With inflation creating pressure on the FOMC, rate cuts will continue to be a difficult decision.

Meanwhile, according to the University of Michigan, consumer sentiment has decreased to its lowest point in nearly three decades.  Gas and grocery prices are steadily increasing nationwide.  The unemployment rate has risen beyond 5%, nearing 8 million people without jobs.

The economic stimulus package will be sent out early next week, and eligible consumers should see the checks for an amount between $300-$600 per person.  Hopefully, the plan will work to give the economy a small boost over the course of the year.