Fed hacks away at interest rates; banks reduce prime to 7.5%.

WASHINGTON -- The Federal Reserve, citing continued sluggishness in the supply of money and credit as well as lower inflation, slashed short-term interest rates again yesterday in two separate actions that brought bank borrowing costs to their lowest level in nearly 20 years.

The Fed sliced the discount rate to 4.5% from 5%, and Fed officials let the federal funds rate slip from 5% to 4.75%. Bond market analysts said they believe the rate cuts -- quickly followed by a reduction by major commercial banks in the prime lending rate to 7.5% from 8% -- will provide some stimulus to a faltering U.S. economy by lowering the cost of credit to businesses and consumers.

At the same time, analysts said that given the bond market jitters in the middle of Treasury's quarterly auction of $38 billion in notes and bonds, it is unclear how much long-term rates can come down in tandem with the Fed's latest relaxation in policy.

"Right now, I think the Fed is more concerned about the economy than anything else and doesn't want to risk a double-dip recession," said Alan Lerner, managing director for Bankers Trust Co. "But we have a global capital shortage on our hands, and the Treasury needs large amounts of money."

The federal Reserve Board's cut in the discount rate came on a vote of 4 to 1 with a dissent from Gov. Wayne Angell, according to a Fed spokesman. The vote occurred in an early-morning meeting a day after the Federal Open Market Committee met to review monetary policy.

The discount rate is what the Fed charges banks for short-term borrowings to meet reserve requirements. The 4.5% rate is the lowest since the period from Dec. 13, 1971 to Jan. 15, 1973.

Late in the morning, the Fed added cash to the banking system in open market operations when federal funds were trading below 5% -- a move than analysts called a clear sign that Fed policymakers are now targeting a funds rate of 4.75%.

Treasury Secretary Nicholas Brady called the Fed's cut in the discount rate "good news for th economy." Lower interest rates "will provide stimulus for economic growth, spur incentive for business investment, and increase consumer confidence," Mr. Brady said, adding, "We hope the Fed's action will quickly be reflected in interest rates charged to consumers and businesses."

Private economists said they expect the Fed's more accommodative stance in monetary policy when combined with the cuts in the prime to bring lower rates on home equity loans, loans for small business, and commercial paper issued by large corporations.

Any improvement in spending and borrowing would be welcome to the Bush administration, which has come under heavy fire from the Democrats for neglecting the economy as public worries about the economy have mounted. On Tuesday, President Bush canceled a planned trip to the Far East to tend to domestic policy.

At the same time, there were lingering questions about how much cuts in interest rates can spice up demand for credit and business activity in general given the drop in consumer confidence reported last week by the Conference Board and other signs that the economy is losing momentum.

"This will show up in the front pages of the newspapers, and maybe people will feel that the outlook for the economy is better and more in the mood to spend money," said Ray Stone, managing director of Stone & McCarthy Research Associates Inc. in Princeton, N.J. "But the Fed is fighting a waning in psychology, so it's not clear to me that this won't do more than keep things from getting worse for a while."

Only last week, Mr. Greenspan conceded that the credit crunch was continuing to hobble the economy despite the Fed's many moves during the year to lower rates. "The Fed seems to be pushing on a string to a degree," said Mr. Stone. "Lower rates don't necessarily make banks want to lend."

Richard Peach, deputy chief economist for the Mortgage Bankers Association, predicted that long rates will move lower as the bond market sees soft government reports on inflation, retail sales, and industrial production over the next two weeks.

"The numbers will probably confirm that the economy is getting progressively weaker and the recovery is, indeed, stalling out, and that'll help long-term rates move even lower," said Mr. Peach. He predicted the average rate on 30-year mortgages will drift down from 8.8% toward 8.5% while 15-year mortgages slide from 8.4% toward 8%.

Any rebound in home sales would be welcome to the housing industry, which has seen sales of single-family homes drop for two months in a row while sales of existing homes appear to have leveled off.

The Fed's statement explaining the cut in the discount rate did not contain any reference to the economy. It only said action was taken "against the background of sluggish expansion of the monetary and credit aggregates in an environment of abating inflationary pressures."

John Silvia, chief economist for Kemper Financial Services Inc. in Chicago, suggested Fed officials deliberately left out any reference to the economy. "I think they want to avoid any hint they're seeking to give a boost to the economy because an election year is coming up," said Mr. Silvia.

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