Fed Cuts Interest Rates to 1 Percent

The Federal Reserve cut interest rates 50 basis points Wednesday in a move that was largely foreseen and isn’t expected to result in any major change in current economic conditions. The Fed’s benchmark federal funds rate is now 1 percent.

“The financial markets were expecting half a point, so the Fed gave them half a point,” Dan North, chief economist at Euler Hermes, a trade credit insurance firm, told insideARM. “The cut will do nothing; it just satisfied the needs of the financial markets.”

The markets are at the point now that additional interest rate cuts mean little, North said, because illiquid credit markets are more of an issue right now than interest rates. And lenders are still reticent to grant credit, though some cracks in the credit blockade are starting to appear, according to North.

Credit won’t ease until lenders have more confidence that they will be able to recover and monies lent, North adds. “It’s possible that credit markets will start loosening up fairly rapidly by the end of the first quarter.”

If credit markets and financial markets take another sharp downturn, the Fed is likely to cut rates another 25 basis points, but probably not until the next scheduled meeting, in December.

But even with the additional economic stimulus and the early actions by the Fed and the Treasury, North expects a recession to last into the second quarter of 2009. If not for the sharp downturn of the financial and credit markets, a rebound might have been expected in the first quarter of the year.

The cut in rates could make some debt easier for holders to repay, said John Jay, senior analyst for Aite Group. The LIBOR rate is likely to drop in tandem with the interest rate cut, so variable interest rates tied to LIBOR is likely to drop as well.

The London Interbank Offered Rate (or LIBOR) is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market.

However, lenders are much less likely to cut rates for other types of loans due to the heightened concern that they may not be repaid, Jay said. “The spread over LIBOR remains huge. Banks want to protect the [interest rate] spread. Even their best customers are starting to delay payments as long as they can. So rates are likely to remain sticky and high.”

Jay also expects the Fed to cut rates again at its December meeting. “The fear of recession is much higher than the fear of inflation right now.”