The Federal Reserve's unanimous decision to slash a key interest rate Tuesday is a dramatic statement that the central bank will do whatever it takes to prevent turmoil in the financial markets and a steep downturn in the housing sector from pulling the country into recession.
By cutting rates so sharply, the Fed indicated it hopes to put a floor under the plunging housing market, steady business hiring and investment, and keep the economy growing as it has for the last six years. A less tangible, but equally important, goal is to restore confidence in the financial markets. Investors got at least a short-term boost after the Fed's announcement, as the stock market posted its biggest one-day point rally since 2002.
Rate cuts take months to fully work their way through the economy, but consumers and businesses could quickly feel some impacts from Tuesday's cut in the federal funds rate to 4.75% from 5.25%. The fed funds rate is what banks charge each other for overnight loans.
After the Fed announced its first rate cut in more than four years, big lenders such as Wachovia, wb Wells Fargo wfc and KeyCorp. key cut the prime rate for their best customers by a half-point, to 7.75%. The prime rate also is the benchmark for the rate on many home-equity loans and credit cards. It often takes one to three monthly billing cycles for lenders to lower rates. Borrowers who take out new loans now, however, will benefit from new, lower rates.
U.S. consumers owe about $800 billion in credit card debt, and a drop of half a percentage point in interest represents about $4 billion in savings for a year's interest, says Robert McKinley, CEO of website CardTrak, which tracks credit card statistics and trends.
"That comes out to about $30 a household per month," he says.
Tuesday's action by the Fed also could lower interest rates on car loans and some mortgages, helping buyers. But savers and investors could feel a pinch as yields on bank certificates of deposit, money market accounts and money market mutual funds fall.
Yields on bank CDs and money market accounts should dip, but probably not by the full amount of the Fed's half-point cut, says Greg McBride, senior financial analyst at Bankrate.com. rate Banks still need the money from consumer deposits to fund loans, which means they will compete by offering slightly higher rates on such accounts.
Tuesday's move represents a dramatic turnaround for Fed Chairman Ben Bernanke, the Fed bank presidents and Fed board governors who voted 10-0 for the rate cut. The Fed had voted as recently as Aug. 7 to hold the federal funds rate at 5.25%.
At that time, the central bank called inflation the main threat to the economy. In later speeches, Fed officials, including Bernanke, made it clear that they were not inclined to cut interest rates to help bail out well-heeled market investors who had made bad business bets.
But Fed officials emphasized that they would act if problems in the financial market were infecting the broader economy. As it became clear in recent days that tightening credit had the potential to exacerbate the housing slump and affect consumer and business spending, the Fed responded.
"Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise," the Fed said in its statement announcing the rate cut.
Another rate cut coming?