In a move to stave off a recession that some economists are giving a 60 percent chance to occur in the coming months, the Federal Reserve Board today announced a 25-basis point cut to the Fed Funds Rate.
At Tuesday's Federal Open Market Committee meeting, the group's final meeting for 2007, the Fed Board of Governors elected to cut the Fed Funds Rate from 4.50 percent to 4.25 percent. Tuesday marked the third time the Fed cut the rate it charges in lending to banks. The rate was 5.25 percent entering 2007.
The cut is likely to have little impact on mortgage rates, says Christian Weller, senior fellow at the Center for American Progress, Washington, D.C., and a professor at the Univ. of Massachusetts, Boston.
"The market has already priced such a cut into its expectations," Weller says. "Consequently, the recent reductions in mortgage rates cover the bulk of the effect that we will likely see."
The Fed Governors also voted to cut the discount rate, the rate banks charge each other for overnight lending, by 25 basis points from 5.0 percent to 4.75 percent. The Fed has now cut the discount rate four times this year. The first cut came in mid-August, lowering the rate from 6.25 percent to 5.75 percent. The next two rate cuts were made at the same time as the Fed Funds Rate cuts.
In announcing its decision, the Fed said that economic growth was slowing, which reflects the "intensification of the housing correction and some softening in business and consumer spending." It added, "Moreover, strains in financial markets have increased in recent weeks. Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time."
In choosing to cut the Funds rate by only 25 basis points, the Fed is demonstrating that it remains fairly confident that the problems in the mortgage markets and in housing overall will not pull the overall economy into recession, says Mark Vitner, senior economist at Wachovia Corp., Charlotte, N.C. Still, the Fed will need to take more action to keep growth positive, Vitner says.
"We believe the economy will avoid a recession but the Federal Reserve will likely have to cut interest rates a little bit further," he says.
Despite the rate cuts to try and open up the flow of credit between banks, and then out to businesses and consumers, most economists project very slow to stagnant growth in the fourth quarter of 2007 and the first quarter of 2008.
Global Insight Inc., of Waltham, Mass., projects Gross Domestic Product growth to hit zero percent in the fourth quarter of 2007, and then stay close to that through the first quarter of 2008, before growth picks up later in the year. Managing director Nigel Gault also estimates that total annual GDP growth for the United States in 2008 will be 1.9 percent.
"The U.S. is entering the danger zone, where growth will be very weak, and there's a real danger of slipping into recession," Gault said.
Vitner sees an even drearier picture, with 2008 GDP growth reaching just 1 percent for the year.
The Fed's rate cuts will have no impact on fixed rate mortgages, but will have some impact on some adjustable rate mortgage products that are tied to United States Treasury Rates. However, most subprime loans, those that are in the most trouble generally, are tied to the London Interbank Offered Rate (LIBOR), which is not impacted.
"Interest rate cuts always have a limited effect on the economy," Weller says. "You can lead a horse to water, but you cannot force it to drink. In this case, just because interest rates are lower doesn't mean that people will necessarily borrow more. Other factors, such as income growth, and expectations about house prices will likely play a large role in their decision to borrow, buy a new house, or expand their homes."