WASHINGTON,
Oct. 31 — The Federal Reserve gave investors what they wanted today, lowering
short-term rates for the second time in two months.
But it quietly warned Wall Street not to expected to assume
that more reductions are ahead.
The move, to reduce short-term rates by a quarter point to
4.5 percent, was aimed at preventing the meltdown in housing from crippling the
rest of the economy. But the vote was not unanimous, reflecting disagreement
among policymakers about the risks that confront the economy.
Investors were generally pleased, and stocks were up
modestly after briefly giving up most of their gains for the day immediately
after the announcement. But Treasury prices fell, reflecting some concerns that
lower interest rates could stoke inflation. Oil prices surged nearly 4 percent
and gold futures were up about 1 percent. The dollar modestly weakened against
other major currencies.
In a statement accompanying its decision, the Fed
acknowledged that the housing collapse is likely to slow the economy. But it
said “some inflation risks remain” and that the risks of inflation were
“roughly balanced” against the risk of slower growth.
That was more sanguine than the view of many investors and
analysts on Wall Street, who have been clamoring for easier money from the Fed.
But it also reflected the conflicting pressures that face the central bank:
despite an unprecedented downward spiral in housing, the rest of the economy
has yet to show signs of serious trouble.
Yet just a few hours before the Fed announced its decision,
the Commerce Department reported that the nation’s gross domestic product
expanded at a healthy pace of 3.9 percent in the quarter that ended Sept. 30.
Consumer spending, which accounts for more than two-thirds
of
America’s
economic activity, climbed 3 percent. Job creation has slowed in recent months,
but employers are still hiring more than firing and wages are rising faster
than inflation. The unemployment rate, at 4.7 percent, is low and has barely
budged.
The most recent data on home sales, housing prices and
construction have all been worse than analysts expected. Defaults have climbed
sharply on mortgages to subprime borrowers with weak credit histories, and
analysts are predicting anywhere from 500,000 to 2 million foreclosures on
subprime loans by the end of next year.
Wall Street firms and major banks have announced billions of
dollars in losses on mortgage-backed securities in the last several weeks, and
Merrill Lynch’s $8.4 billion write-down was among the factors that led to the
ouster of its chief executive, E. Stanley O’Neal, earlier this week.
Fed officials and private economists alike have predicted
that the housing market has yet to hit bottom. Housing starts in September were
down 31 percent from the year before. Sales of existing homes have dropped 30
percent since their peak in 2005, and the supply of unsold homes last month
reached its highest level in more than 19 years.
The nationwide average price of homes have declined almost 5
percent in the last year, the first time on record that has happened in the
United States.
On Tuesday, Standard & Poor’s reported that its Case-Schiller index of
housing prices in 20 major cities had declined 4.4 percent in August, compared
with a year earlier. That was the eighth consecutive monthly decline, and the
steepest since April 1991.
“If the Fed is in the business of managing risks, as it
claims to be, the argument in favor of easing is, in our view, overwhelming,”
wrote Ian Shepherdson, an economist at High Frequency Economics, in a research note
on Tuesday.
But at least some Fed officials have worried about reacting
too strongly. The president of the San Francisco Fed, Janet Yellen, cautioned
in a speech last month that the Fed cut rates dramatically after the Russian
financial collapse in August 1998. Then, as now, credit markets began to freeze
up as investors worried about defaults. But the fear abated and the economic
boom did not slow that year.
At the Fed’s policy meeting on Sept. 18, 5 of the 12
regional banks did not request a reduction in the discount rate, the rate at
which banks can borrow directly from the Fed. That was a quiet sign that some
Fed presidents did not yet see the need for lower rates at that time.
Lyle E. Gramley, a former Fed governor and now a senior
adviser to the Stamford Washington Research Group, said some policy makers were
worried that rising wages and slower productivity growth could aggravate
inflation.
“Unless productivity improves or the rise in compensation
slows down, unit-labor costs will be rising too rapidly to keep core inflation
down to 2 percent,” Mr. Gramley said. “That’s what’s got them worried.”
But Fed officials were under heavy pressure from financial
markets. Prices of Fed-funds futures, which provide a way of betting on the
Federal funds rate, showed that investors placed the odds of a rate cut on
Wednesday at 96 percent.
Had the central bank decided to leave interest rates
unchanged, without any advance warnings from policy makers, the stock markets
would likely have plunged in panic.
Instead, policy makers were expected to give investors the
rate cut they expected but also to warn against assuming additional rate cuts
later this year.
The board also approved a 25-basis-point decrease in the
discount rate to 5 percent.
