The Federal Reserve cut key U.S. interest rates by half a percentage point today, in a direct response to the stalling economy and an urgent attempt to prevent the country from falling into recession.
The Fed said the current economic deterioration called for a "rapid and forceful" response and signaled it would act again if needed.
The move, which was widely expected by financial markets and followed a surprise half-percentage point rate cut earlier this month, took the bellwether fed funds overnight bank lending rate to 5.5 percent from 6 percent, and erased all the rate increases of 2000.
To underline its determination to keep the record U.S. expansion on track, the powerful central bank also cut the discount rate on direct Fed loans to commercial banks by a half-point to 5.0 percent.
Stocks closed mixed after initially falling as the news broke. Investors interpreted the Fed's mid-afternoon announcement as a reason to take profits from the market's recent gains. Although they know lower rates should eventually lift earnings and the economy, investors weren't sure how long that would take.
The Fed's Reasons
In a statement released after a two-day session of the rate-setting Federal Open Market Committee, the Fed said it still views excessive weakness as the main risk to the U.S. economy, suggesting it remains open to further rate cuts should the economy continue to deteriorate. The FOMC next meets on March 20.
Justifying its decision, the Fed said: "Consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins." It also cited the resulting drag on retail sales and business spending on capital equipment.
David Jones, chief economist at Aubrey G. Lanston, a New York Securities firm, said the Fed is showing a rapid and forceful response and will continue to do so as needed to keep the country out of an economic crisis. "My guess is that we won't go into an all-out recession. We'll flirt with a recession in terms of seeing approximately no growth in the first quarter of this year, but I do believe the Fed will cut rates enough."
"By cutting interest rates for the second time in a month, the Fed is trying to do anything it can to keep economy from weakening further. They are concerned about declining consumer and business confidence," added Gary Thayer, chief economist at AG Edwards & Sons in St. Louis.
Widely Anticipated Move
Ahead of the announcement, analysts were nearly unanimous that the Fed would slash rates to 5.5 percent to signal its wish for cheaper credit as a stimulant for a sluggish economy.
Many noted that Fed Chairman Alan Greenspan, in testimony to lawmakers last week, said it was a "critical issue" whether weakening sales and production were enough "to breach the fabric of consumer confidence."
Richard Rippe, chief economist at Prudential Securities in New York, said today's announcement was so important because the economy's flirtation with recession has made it vulnerable. "The good news here is that help is on the way. The Fed will be cutting interest rates further and there's likely to be a tax cut enacted and those measures should gradually begin to improve the economy's performance."
But not all economists see the economy heading into a downward spiral. Benjamin Friedman, an economics professor at Harvard University, said it's too early to talk about recession, but he acknowledged an interest rate cut is necessary to heat up a cooling economic boom. "I think there's more to be done in the way of lowering interest so as to stimulate activity, making it easier for individuals, businesses and homeowners to borrow."
Substantial Slowdown in Economy
More evidence of the slowdown came earlier today, when the government reported that the powerhouse economy slowed sharply in the closing quarter of 2000, posting the weakest growth in five and a half years as consumers clamped their purses shut and goods piled up on store shelves.
Gross domestic product, which measures the value of all goods and services produced within U.S. borders, advanced at a lackluster 1.4 percent annual rate during the October-December fourth quarter, down from 2.2 percent in the third quarter.
It was the slowest pace of GDP increase for any three-month period since a 0.8 percent rise in the second quarter of 1995 when the economy also was coping with overstocked inventories.
Friedman added recent reports about the slowing rate of job creation as yet more evidence of a slowdown. "We've had substantial layoffs and if this continues for more than another couple of months, then the unemployment rate will increase. "
Balancing Growth and Fears
This is the second big rate cut in less than a month and amounts to a full one percent drop in interest rates since Jan. 3. The Federal Reserve hasn't taken such dramatic action since December of 1991, more than nine years ago. The country was just beginning to emerge from the recession that played a key role in Bill Clinton's defeat of then-President George Bush.
Greenspan told Congress last week that the mighty U.S. economy, now in a record 10th year of expansion, had "slipped very dramatically" and that growth was "close to zero."
Although the Fed cut rates today, the impact may not be immediate, according to Rippe. "It takes six to 12 months for the full impact to be visible, but there's a psychological benefit that comes sooner." He added that businesses and consumers tend to feel more confident if they feel the Fed is doing everything possible to improve the economy.
Stuart Hoffman, an economist at PNC Financial Services Group also pointed out that "the Fed doesn't want to risk a self-fulfilling prophecy of recession, so the rate cut will be aimed at shoring up confidence in the knowledge that it takes many months for these rate reductions to impact the economy positively."
Markets saw Greenspan's words as confirmation that the Fed chief thought an aggressive cut was in order. Ahead of the news, investors were betting that a big rate cut was in the cards, as the Dow Jones Industrial Average soared 179.01 points Tuesday to close at 10,881.20 while the high tech-laden Nasdaq composite index tread water to end virtually unchanged at 2,838.35.
A brighter stock market picture, after a bout of exceptional weakness in the second half last year, is one thread of hope that a downturn might be temporary. Cheaper interest rates have also helped buoy the housing market as cheaper mortgages have kept a floor under building and sales.
ABCNEWS.com's Romy Ribitzky, ABCNEWS Radio's Bill Greenwood, Reuters and The Associated Press contributed to this report.