Fed slashes key rate half a percentage point to 1.0%

WASHINGTON -- The Federal Reserve slashed interest rates a half-percentage point to the lowest level in more than four years Wednesday as policymakers try to limit the pain of an economic downturn.

Saying the economy had "slowed markedly," Fed Chairman Ben Bernanke and his colleagues cut their target for a key short-term interest rate to 1%, lowest since June 2004. Before then, rates had not been that low since 1958.

The decision to cut rates Wednesday was unanimous.

In their post-meeting statement, Fed policymakers pointed to a drop in consumer and business spending and industrial production. They also said slowing economies abroad would likely lead to a slowdown in exports, which have provided a significant boost to the U.S. economy.

"The intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit," the Fed said.

U.S. central bankers say they expect inflation to continue to ease, given falling prices for energy and other commodities. That could give them room to cut interest rates further.

The 1% federal funds rate target is what banks charge each other on overnight loans. The Fed also cut the discount rate, which it controls directly, to 1.25%. That is the rate it charges banks to borrow from the Fed's discount window.

Lower interest rates should eventually encourage consumers and businesses to borrow money once the crisis in credit markets eases. That will help the economy recover as people buy homes, machinery, cars and other items, PMI Group chief economist David Berson says.

"It may not be spent initially," Berson says. But "liquidity is always eventually spent when it has been added."

The Fed's move is unlikely to have an immediate impact on lending as nerves are keeping banks on the sidelines, no matter the cost of money. "The issue is not lack of liquidity," says Tucker Hart Adams, owner of the Adams Group, an economic consulting firm.

But, said John Derrick director of research at U.S. Global Investors, "It may boost confidence a little bit. It may boost sentiment."

While it is likely the Fed cannot prevent the USA from sinking into recession — most economists say we are there already — central bankers can try to make the downturn less severe.

The Fed last cut interest rates in an unprecedented, coordinated move with central banks around the globe Oct. 8 as financial turmoil gripped near-frozen lending markets.

Other central banks will likely follow the Fed's lead and cut interest rates again, predicts Mission Residential chief economist Richard Moody. China cut rates earlier Wednesday, for the third time in six weeks. Norway also lowered borrowing costs.

"It is a global recession now," Moody says.

As is usually the case when the Fed cuts rates, savers will suffer. Rates on certificates of deposit, which have already been falling, will drop further. The average yield for a 1-year CD was 2.7% last week, down slightly from a week earlier, according to Bankrate.com. The average yield for a 5-year CD also fell slightly last week to 3.46%.

Banks are seeing a flood of money from investors seeking sanctuary from the volatile stock market, and much of that money is making its way to CDs, according to Bankrate. That means banks don't need to offer high interest rates to attract money. Nonetheless, savers who shop around can still find competitive rates of 4% or more for 1-year CDs.

Many banks are eager to increase deposits because the credit crunch has dried up other sources of funds, says Greg McBride, senior analyst for Bankrate.com. "As long as the credit crunch persists, banks are going to remain hungry for deposits, and that will keep yields from falling too far," he says.

While lower short-term interest rates usually benefit borrowers, this rate cut won't provide much relief for many credit card holders. Banks that issue variable-rate credit cards often set a "floor" for interest, and in some cases, their rates have already hit that floor. As a result, even those with good credit may not see their credit card rates decline.

Interest rates are just part of the arsenal that the Fed has been deploying to thaw credit markets and boost the economy. The Fed has opened so-called swap lines with foreign central banks, most recently with the Reserve Bank of New Zealand on Wednesday, to keep dollars flowing abroad.

And the Fed this week started to buy corporate commercial paper, to lend short-term cash to companies to meet payroll and other immediate needs. The U.S. central bank has also provided financing for the rescue of insurer AIG and the sale of investment bank Bear Stearns.

The United States has not been in a recession since 2001, one of the shortest and shallowest downturns in history. Economists say this downturn will likely be longer and deeper, according to a USA TODAY survey last week.

Recent data paint a dark picture. Wednesday, the government said although orders for long-lasting durable goods rose in September, the gain was led by a sharp rise in orders for aircraft, which are costly and can skew the overall number. A proxy for business spending, nondefense capital goods orders excluding aircraft, fell for a second consecutive month in September.

With such negative news coming in, some economists expect the Fed to cut rates again before the end of the year. Moody's Economy.com economist Augustine Faucher predicted another half-point cut in 2008 in a note to clients Monday.

The Fed next meets Dec. 16.

Contributing: USA TODAY's Sandra Block