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Key Rate Slashed; Stocks Soar

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By JEANNINE AVERSA, The Associated Press

Published: September 19, 2007

Updated: 09/18/2007 09:11 pm

WASHINGTON - In a bold strike, the Federal Reserve slashed a key interest rate by a half point Tuesday - the first cut in more than four years - and left the door open to further relief to prevent a painful housing slump and jarring credit crunch from driving the country into recession.

Wall Street responded enthusiastically, propelling the Dow Jones industrial average up 335.97 points to 13,739.4 - its biggest one-day point jump in nearly five years. Politicians, shaken by record-high home foreclosures, also welcomed the move.

'The market is acting like Federal Reserve Chairman Ben Bernanke just cured cancer, and, I can tell you, he didn't,' said Art Hogan, chief market strategist at Jefferies & Co. 'This is typical of the knee-jerk reaction to what we perceive to be good news.'

The broader indexes also soared, with the S&P 500 index up 43.13 points, or 2.9 percent, at 1,519.78, and the Nasdaq composite index up 70 points, or 2.7 percent, to 2,651.66.

In a crucial and anxiously awaited decision, Bernanke and his central bank colleagues lowered an important interest rate to 4.75 percent. Economic and political pressure has been building on the Fed to act.

As a result, Wells Fargo, Bank of America and other commercial banks dropped their prime lending rate charged to millions of borrowers by a corresponding amount to 7.75 percent.

'All but 23 economists were surprised,' Alan Skrainka, chief market strategist at Edward Jones, said of widely made forecasts that the Fed would trim its overnight interest rate target by just a quarter of a percentage point.

'The Fed finally recognizes what most of Wall Street has known for some time: that there is a greater risk of weakness in the economy than inflation,' Skrainka said.

The Fed's action means borrowers who can obtain credit should see rates drop on a variety of loans. It will become less expensive for people to finance certain credit card debt and for homeowners to take out popular home equity lines of credit, which often are used to pay for education, home improvements or medical bills.

And it will help some homeowners whose adjustable-rate mortgages reset in the fall. Those rates will still go up, but not by as much as they otherwise could have, analysts said.

'My personal opinion is that this was more for show,' said Greg Ghodsi, senior vice president of investments at the 360 Wealth Management Group of Raymond James & Associates in Tampa. 'The effect on Mr. and Mrs. Investor is going to be very, very minimal right now.'

Jerry Divers, president of Bank of Tampa, agreed the cut was a 'psychological maneuver' meant more to 'satisfy Wall Street than to satisfy the economy.' He said it will make 'virtually no difference' to people and businesses in the Tampa Bay area.

Why the skepticism? It can take months for a Fed rate cut to ripple through the economy and reach consumers, and the troubled housing market and recession fears still weigh heavily on Wall Street. Also, experts predict it will take several rate cuts, not just one, to right the economy.

In general, Fed rate cuts favor younger investors, not retirees who depend on their investments for income.

Less immediate will be relief for the country's economic health. The rate reduction could take three to nine months to ripple through the economy and bolster overall activity.

But the aggressive action underscored the Fed's resolve.

'The Fed has rolled out the heavy artillery here. Bernanke is not being timid,' said Brian Bethune, economist at Global Insight. 'The Fed has seen the problems. It is not trying to put out a forest fire with a bucket of water.'

Bethune and some other analysts predict the Fed will lower rates again - probably by a more modest one-quarter percentage point - at its next meeting in October. Another rate reduction could come in December, the last meeting of this year, if the economy were to falter.

Ahead of the Fed's much-anticipated move, the Labor Department reported wholesale prices fell 1.4 percent in August, led by falling food and energy prices. However, the core producer price index climbed a greater than expected 0.2 percent.

The producer price index report, however, may not have had a great bearing on deliberations by the Fed, which focuses on consumer, rather than wholesale, prices.

The dollar tumbled to a new all-time low against the euro after the rate cut, because lower rates make a currency a less attractive investment. Crude oil futures catapulted further into record terrain, rising 94 cents to $81.51 a barrel, and gold prices rallied to a multidecade high.

These factors could add up to trouble for the consumer. Though the Fed tends to measure inflation after stripping out volatile food and energy prices, high commodity costs trickle down to average Americans and can dampen their spending power.

Fears that the troubled housing market and credit problems could short-circuit the six-year-old economic expansion have shaken Wall Street.

The biggest worry is that people and businesses will cut back on their spending and investment, throwing the economy into a tailspin. Tuesday's rate cut is aimed at making sure that doesn't happen.

Former Federal Reserve Chairman Alan Greenspan, in an interview Monday with The Associated Press, said the odds of a recession are growing.

'Obviously, the odds have moved up to more than a third, but I doubt if we are anywhere near 50 percent yet,' Greenspan said. Earlier this year, his prediction of a one-in-three chance of a recession caused Wall Street to nose dive.

The free flow of credit is important to the smooth functioning of the national economy. If credit becomes too difficult to get, it can put a damper on peoples' ability to buy big-ticket items, such as homes, cars and appliances. And it can crimp businesses' capital investment and hiring.

Tribune reporter Dave Simanoff contributed to this report. Information from MarketWatch also was used.

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