Seeing no relief, Fed offers some

Wall Street responded instantly to the surprise rate cut, seen by some as an effort to boost corporate confidence.

The Federal Reserve's surprise decision to lower interest rates again is a signal of how anxious the nation's central bankers have become about the US economy - and how far they're willing to go to correct it.

With its emergency half percentage point drop yesterday, the Fed has now lowered short-term rates by two full points in less than four months - the most aggressive action by the nation's central bank in 16 years.

The move is seen by some economists as an attempt to shore up the confidence of US business in particular. Consumer spending and retail inventories have not been that bad in the current economic downturn.

But many corporations have not responded to earlier interest cuts. They haven't been investing heavily in the new plants and equipment that are central to boosting productivity - one of the key drivers of the boom of the 1990s.

"The Fed is saying that we have to do our part to shore up the willingness of CEOs to continue to do capital spending," says Dave Orr, chief economist for First Union Bank in Charlotte, N.C. "If they don't continue to spend money, productivity will not continue to rise and that is really the basis of a real solid recovery."

The depth of the cut shows how pessimistic the Fed has become. "The risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," the Fed said in an announcement.

Wall Street was delighted with the move. Stock prices rose like a July 4th rocket.

The central bank made a similar surprise cut at the start of the year when the economy slowed sharply toward the end of 2000.

The latest move put the Federal Funds rate, the interest banks charge on overnight loans to one another, at 4.5 percent. The reduction promises to save millions of Americans money on their home equity loans or car loans. Mortgage rates should drop also.

Some economists suspect that the reason for the drop now is that the Fed and the White House have been hearing a lot from friends in the corporate world. Certainly, the signs of a reduction in capital spending have been stark in recent corporate earnings reports. On Tuesday, Intel reported one of its worst quarters in years, and Cisco Systems said it was eliminating 8,500 jobs.

Still, the latest drop will not automatically prompt businesses to open their wallets. "There won't be the huge spending as we have seen," says Dave Heuther, director of economic analysis at the National Association of Manufacturers in Washington. Rather, he thinks this rate cut will ensure that the economy turns around in the second half as corporations reduce their inventories.

Much hangs on the economy remaining prosperous. The GOP's prospects of maintaining control of Congress could decidedly fade should the slump deteriorate into a genuine recession with falling output.

Moreover, there are already signs that those at the low end of the income ladder are being hurt by weakening job prospects. Unemployment has climbed 0.4 percentage points from its low to 4.3 percent. But for blacks, the jobless rate has jumped 1.4 percent to 8.6 percent. Hispanic unemployment has risen seven-tenths to 6.3 percent.

Further, income inequality shows signs of rising again. At the other end of the income scale, the weak stock market has trimmed some spending, at least in luxury goods. Almost $5 trillion of paper wealth vanished since March 2000.

The Fed worries about this, referring specifically to "the possible effects of earlier reductions in equity wealth on consumption."

Another concern was the risk of slower growth abroad. Last week the European Central Bank refused to trim interest rates. But it has come under mounting pressure from politicians, economic think tanks, and trade unions to lower rates to give a boost to the 11-nation euro zone economy. The Fed's action may add to that pressure.

One factor that made the Fed's action possible is the relatively low inflation rate. Earlier this week, the Labor Department reported that consumer prices rose only 0.1 percent in March. Stan Shipley, an economist with Merrill Lynch, predicts that core inflation - minus energy and food prices - will drop to about a 2 percent rate by year end.

Other favorable factors in the economy noted by the Fed were a "a significant reduction in excess inventories" and the relative stability of spending by consumers on both housing and consumer goods.

Consumer confidence, though, has been slipping. The Conference Board, a New York-based business research firm, reported yesterday that the US index of leading economic indicators - a gauge of future economic activity - fell 0.3 percent in March after a 0.2 percent decline the previous month.

The board said the index is not declining fast enough to signal a recession.

The Fed's latest move may help blunt some of the criticism on Capitol Hill that Mr. Greenspan hasn't been acting boldly enough to correct the economy. Rep. Jim Saxton (R) of New Jersey, incoming chairman of the Joint Economic Committee of Congress, is one of the ones who has voiced concern about the lack of Fed action. Today he said he was "pleased to see the [Fed's] actions."

Staff writers Ron Scherer and Alexandra Marks contributed to this report.

(c) Copyright 2001. The Christian Science Monitor

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