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Fed is likely to cut rate again to ease tight credit
Some economists think the benchmark could reach a record low as the Federal Reserve works to bolster the economy.
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WASHINGTON - When it comes to the Federal Reserve these days, one question dominates: How low will it go?
The central bank has cut its benchmark rate to 1 percent, but most economists think the Fed's rate-setting committee will take that down another notch or two when it ends a two-day meeting in Washington on Tuesday.
The consensus bet is that the Fed will lower its benchmark rate to 0.5 percent, but a few economists say they wouldn't be surprised if the Fed takes it way down to 0.25 percent, which would be the lowest on record.
If it happens, the cut in the federal funds rate would be the latest in a series of steps by government regulators to thaw the near-frozen credit markets and slap some vigor into the economy.
Banks will find it a little less expensive to lend money. And consumers with home equity loans and certain credit cards also will see lower interest rates, perhaps enticing them to spend some of the money they save on their debt payments.
On the downside, many savers will see lower interest payments on their deposits. And some economists worry that cutting the Fed's benchmark rate below 1 percent would strain money market mutual funds, making it harder for them to cover basic administrative costs.
Peter Kretzmer, chief U.S. economist at Bank of America, said that concern has eased in recent weeks as the funds have found new strategies to cope with the rare, low-rate environment.
Indeed, any change in the target rate will have little practical effect, because the actual rate has been well below the 1 percent level for weeks. In fact, the average daily funds rate in November was 0.39 percent, according to Fed statistics.
Kretzmer said that the effect of officially setting the target below 1 percent is mostly psychological, a signal that the Fed is committed to healing the financial markets and the rest of the economy.
"It's not as though what they announce tomorrow is going to affect the effective rate," Kretzmer said. "What's going to matter is what they say in the statement."
The statement that accompanies the rate announcement usually gives Fed governors' view of the direction of the economy. But this month it also is expected to give investors and the rest of the public new insights into how the Fed operates.
Late last month, Fed governors announced that they would begin buying up some of the troubled securities that have been clogging the financial pipes since the summer, taking the securities onto their own balance sheet. Like lowering interest rates, that kind of direct purchase of securities expands money supply; economists have dubbed it "quantitative easing."
The Fed statement is expected to indicate that going forward, the central bank will concentrate more on quantitative easing than interest rates.
On Nov. 25, the Fed announced that it would spend as much as $800 billion buying up the securities that fund consumer credit including mortgages, student loans, auto loans and credit cards. The Fed has made an initial purchase of $15 billion in mortgage securities issued by Fannie Mae and Freddie Mac and expects to buy $85 more in months to come. Another $500 billion will be spent on privately issued mortgage securities and $200 billion on so-called "asset-backed" securities that fund student loans, auto loans and credit cards.
As soon as the Fed made the announcement, mortgage rates began to fall -- a sign, Jones said, that those purchases will do more to fix the financial markets than any of the Fed's other actions to date.
If all goes well, economists say, the Fed eventually will have to cut back the money supply before inflation takes hold. But the Labor Department is expected to confirm Tuesday that signs of inflation at the consumer level have all but disappeared.
At the same time, the overall health of the economy is still critical. The Fed released industrial production numbers Monday that showed a 0.6 percent drop in November, led by a steep 1.4 percent decline in manufacturing.
Chairman Ben Bernanke clearly has indicated that the Fed has put inflation concerns on the back burner.
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