Fed votes to reduce funds rate to 5.25%

The quarter-point cut in the federal funds rate to 5.25 percent will mean slightly lower borrowing costs for millions of Americans on everything from auto loans to home equity lines of credit if commercial banks, as expected, follow suit in coming days by lowering their benchmark prime lending rates. The prime rate is currently at 8.5 percent.

Wall Street, which had hoped for a bigger rate cut, sent stock prices plunging by more than 100 points after the Fed announcement but later recovered somewhat. The Dow Jones industrial average ended the day down 28.32 at 8,080.52.

Congressional critics, who have complained that the Fed has been slow to recognize the threat of Asian economic troubles to American manufacturers and farmers, were also unhappy.

"America and the rest of the world needs stronger action by the Federal Reserve," said Sen. Tom Harkin (D-Iowa). "The weakening of foreign economies is dragging down the U.S. economy."

Private economists, however, said that yesterday's decision to lower the federal funds rate, which has been at 5.5 percent for 18 months, still represented a remarkable turnaround for Fed policy-makers, who as recently as July were leaning toward raising rates to fight inflation.

Many economists said yesterday's reduction was probably just the first of a series that would send the funds rate down by a full percentage point over the next year.

"It is better for the Fed to take it step by step so long as they don't take too long between steps," said Allen Sinai, chief global economist at Primark Decision Economics.

Federal Reserve Chair Alan Greenspan first signaled the Fed's change of heart earlier this month when he warned that the United States was unlikely to remain an "oasis of prosperity" in the face of a currency crisis that began in Asia, then spread to Russia in August and is now threatening countries in Latin America.

So far, the main impact on the United States has been to send the trade deficit to record levels. American exporters have lost valuable overseas markets, and Asian products, made cheaper by currency devaluations, have flooded into this country.

But Russia's botched devaluation of its currency brought the crisis closer to home by disrupting Brazil and a number of Latin American countries, prompting panicked investors to flee those countries' markets.

With Clinton administration officials working behind the scenes to help the International Monetary Fund come up with a multibillion-dollar bailout for Brazil, Greenspan indicated last week that the Fed stood ready to do its part to calm turbulent markets.

U.S. companies depend on Latin American countries for many of their sales.

Lower U.S. interest rates help to ease interest rate pressures in foreign countries as well and also build confidence that the United States will remain a buyer-of-last resort.

Private economists said the Fed may have also been prodded to make the rate cut after central bank officials were forced to broker a $3.5 billion bailout for a Connecticut hedge fund.

David Jones, chief economist at Aubrey G. Jones & Co. in New York, said Greenspan may have run into opposition for a bolder half-point cut from Fed officials who cite the lowest unemployment rate in nearly three decades and continued strong consumer demand as offsets to the foreign weakness.

"This was a difficult decision for the Fed. It is rather hard to make a convincing case for lower interest rates in the United States at the present time," said former Fed board member Lyle Gramley, economist with the Mortgage Bankers Association. "The Fed was taking this as a psychological step to settle markets down internationally."

The Business Roundtable and other business groups who had been pushing for rate cuts applauded the action while urging more rate cuts down the road.

"Given that one-third of the world is recession, lower rates are essential," said Jerry Jasinowski, president of the National Association of Manufacturers.

While a number of banks in Canada, a nation whose economy is closely tied to the United States, announced cuts in their prime lending rates immediately after the Fed's announcement, officials at major U.S. banks said they were still considering whether to lower their rates.

However, private analysts said they expected U.S. banks would lower their prime rate within the next few days. Some suggested that the delay would last until Thursday, the first day of October, so the banks would not have to pass on lower rates to consumers holding adjustable home equity loans for another month.

09-30-98