Fed cuts discount rate in surprise move

Fed cuts discount rate in surprise move
By Eoin Callan in Washington
Copyright The Financial Times Limited 2007
Published: August 17 2007 14:27 | Last updated: August 17 2007 14:27


The Federal Reserve took emergency steps to limit the damage to the US economy from the crisis in global credit markets on Friday by cutting the discount rate at which it makes loans to banks.

The central bank cut the rate by half a percentage point to 5.75 per cent, while keeping the main federal funds rate on hold at 5.25 per cent.

The surprise move, which was agreed during an emergency conference call on Thursday night, makes it more likely the Fed will cut its main rate next month and may help ease liquidity in financial markets and limit the blow to financial institutions from the deterioration in assets exposed to the meltdown in the US subprime mortgage sector.

The statement shows that the Fed has abandoned its hawkish bias towards raising rates to combat inflation, and has moved to a neutral stance and is ready to cut interest rates.

In the unexpected announcement, the Fed said: ”Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward.”

The central bank ”is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets”, the statement added.

The move is a reversal for the Fed, which previously played dow the impact on the economy from the crisis building in the high-risk end of the US home loan market.

The cut in the lending rate follows warnings from Wall Street economists that the turbulence in financial markets was hitting banks’ balance sheets and might limit their ability to lend and meet their obligations.

This could resulted in a further tightening of lending conditions and an increase in the cost of borrowing that would begin to have effects on businesses and households seeking credit and the wider economy.

Bruce Kasman, chief economist at JP Morgan, told the Financial Times: “Assets are being transferred back onto the balance sheets of banks and financial institutions, making them more reluctant to lend. They have less capacity to lend and they are uncertain if they can meet their credit obligations.”

Policymakers added: ”Although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably.”

The announcement follows large-scale intervention by the Fed and major central banks to inject liquidity into overnight lending markets, which had seized amid fears about where losses on mortgage-backed securities were hidden in the financial system.