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The U.S. Federal Reserve Board cut benchmark U.S. interest rates

The U.S. Federal Reserve Board cut benchmark U.S. interest rates by a modest quarter-percentage point Tuesday to help the U.S. economy withstand tightened credit and a prolonged housing slump, disappointing Wall Street, which had hoped for more-aggressive action.
The central bank's decision takes the bellwether federal funds rate, which governs overnight lending between banks, down to 4.25 per cent. While the action was widely expected, some economists had thought the Fed might offer a bolder half-point reduction in the rate.

The blue chip Dow Jones industrial average was down more than 130 points within minutes of the Fed's announcement of its action, while prices for U.S. government bonds and the value of the U.S. dollar rose.

The Fed has now cut overnight rates, their key economic policy lever, by a full percentage point since mid-September in an effort to put a floor under an economy increasingly seen at risk of falling into recession. In a related move, the Fed trimmed the discount rate it charges for direct loans to banks by a matching quarter point to 4.75 per cent.

“Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time,” the Fed's policy-setting Federal Open Market Committee said in a statement outlining its decision.

The Fed noted that financial strains had increased in recent weeks and said some inflation risks remain. It refrained from offering its usual assessment of the balance of risks facing the economy.

“Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,” it said.

The Fed's decision follows renewed deterioration in credit markets after major financial institutions around the world reported billions of dollars worth of writedowns due to extensive exposure to delinquent mortgages.

Markets and policy-makers have been caught off guard by how hard and broadly rising defaults on U.S. subprime mortgages have hit. As roughly 1.8 million adjustable rate mortgages line up for reset at sharply higher interest rates in 2008, the prospect of more pain for homeowners and banks has loomed increasingly menacingly since the Fed last met in October.

At that meeting, the Fed lowered the federal funds rate by a quarter point to 4.5 per cent, a move that followed a surprisingly large half-point cut in September, and said the risk of a pick-up in inflation was roughly equal to downside risks to economic growth.

Since then, yields on short-term U.S. Treasury bills have slipped to their lowest levels since August, when credit markets first began to freeze up, as investors again sought a safe haven.

In addition, the short-term London Interbank Offered Rate, a widely used global lending benchmark, has remained elevated. Many U.S. adjustable rate mortgages are tied to Libor.

The high Libor rate and low yield on Treasury bills reflect banks' nervousness about lending out their cash, analysts say.

Paradoxically, the U.S. economy logged a sturdy performance in the third quarter, with growth clocking in at a 4.9 per cent annual rate.

However, even as hiring has remained steady, consumer spending appears to be softening and a large overhang of unsold homes likely means any recovery in the battered housing market is still some ways off.

With home prices sliding and borrowing conditions tightening, many forecasters are warning that the economy is skirting close to recession.

The No. 2 official at the International Monetary Fund said in an interview published Tuesday that U.S. recession fears were overblown.

“Never say never, but the latest indicators do not justify such a conclusion,” IMF first deputy managing director John Lipsky told an internal IMF publication.

© The Globe and Mail
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