The Federal Reserve lowered the federal funds rate, a key short term interest rate banks charge each other, by a quarter percent to 4.5% this afternoon.  While this was not the 50 basis point cut Wall Street was hoping for, investors still greeted the news warmly, as stock finished the day with modest gains.  The Federal Reserve also cut the discount rate to 5%, the rate that it charges to other banks as the lender of last resort. 

Releasing this statement, the Fed acknowledges it is still concerned with inflation and is monitoring it closely, citing volatility in the energy and commodity prices.  Not surprisingly energy prices rose to an all time high after news of the rate cut was announced.  The beleaguered dollar also reached an all time low against the Euro and most analysts expect this trend to continue.

What does this all mean?  Well, they pretty much told the market this is all your going to get so you had better make the most of it.  Inflationary pressures from the commodity and energy markets will take time to affect the prices of the broader economy but eventually you can expect companies to pass on their higher costs to the consumer.  If inflation starts to rear it’s ugly head, you can expect rate hikes from the Fed in the future even if the housing market continues to slump.

Will this rate cut be enough?  It is difficult to say really.  The housing sector will take time to improve, but the real problem is in the financial markets.  Still weary over losses from the sub prime mortgage market, many institutions have to rethink the way they do business.  Unless a concerted effort is made by them to help forestall rising foreclosure rates, I don’t see the housing crisis ending anytime soon, so the economy could be in for a rough time ahead.

Much of Wall Street are hoping that the Federal Reserve will lower interest rates again in the near future. While many people think this will be the salvation to the woes of the financial sector, it’s not that cut and dry.

The mandate of the Federal Reserve is to achieve both price stability and maximum sustainable employment. This can be a very tricky balancing act in the best of times. Recessions will hurt in the short run but runaway inflation is something no economy wants to go through.

Interest rates affect many different aspects of our economy. While lower interest rate will spur economic growth that isn’t the only consideration. Interest rates have a large impact on exchange rates. An already weak dollar will be further weakened as lower interest rates mean our national debt is less attractive to foreign investors. A weak dollar means our exports are cheaper for foreigners and imports are more expensive for us.

In a previous article in this section I talked about high energy and food prices and whether Americans should be concerned about inflation. Think energy prices are high now? Well guess what, we import most of our oil so a weaker dollar means it will cost us even more in the future. Think food prices are high already? Well we export most of our food and you guessed it, since it will be cheaper to foreigners, demand will increase and prices will go up.

Need I remind you that our current financial crisis arose from when the last time interest rates were at rock bottom, banks and lenders awash in liquidity made many ill advised loans that are coming back to haunt them now. So while Wall Street might welcome an interest rate cut with open arms, us little guys shouldn’t be too quick to join them.

Finance companies have been taking a beating recently in the stock market. Industry giant Merrill Lynch reported a $7.9 billion write off earlier this week, a much larger loss than analysts anticipated. This prompted a large sell off of the stock this past week, although the stock did recover slightly as some investors came in at the end of the week seeking bargains.

They aren’t alone in reporting huge losses in the third quarter as the crisis in the sub-prime mortgage market is having a huge effect in this sector. Some analysts believe the only thing keeping the general stock market afloat has been a very strong tech sector. Many are predicting that the woes of the financial sector will only get worse.

A large number of adjustable rate mortgages are about to reset upwards in the upcoming year and the general consensus is that foreclosure rates will climb even further. An already weak commercial paper market is also expected to get worse. Investors are hoping and praying that this will prompt the Federal Reserve to lower interest rates by another 50 basis points.

The general economy remains strong but many fear that a continued weakness in the housing sector could lead to a slowing of growth and could have an impact on other segments of the economy as it already has on the financial sector. While no one wants to talk about a recession, it is on the back of many investors minds.