The Federal Reserve lowered a key short-term interest rate on Tuesday, signaling its growing concern about the effect of global financial problems on the nation's economy.
The Fed cut its target for the federal funds rate by a quarter of a percentage point, to 5.25%, ending 18 months of stable official rates. Banks were expected to respond with similar cuts in their prime lending rate.
The move was in line with the Fed's gradualist approach to monetary policy under Chairman Alan Greenspan, but was greeted with disappointment by many investors, who had hoped for a half-point cut.
Bank and other financial stocks, as well as the overall market, initially fell on the Fed action, then recovered some ground.
Though small and mostly symbolic, the quarter-point cut may still provide some boost to earnings prospects for commercial banks-and particularly thrift institutions-by edging the rate structure known as the yield curve toward a more normal shape, thus making it easier to profit from lending.
The Fed's purpose, in this case, was not to address any serious problems in the U.S. economy. Instead, it moved to calm waters elsewhere before the waves reach here.
Departing from its typically spare remarks, the Fed's Open Market Committee referred specifically to global economic problems and international market tumult, suggesting to many central bank watchers that further rate cuts are ahead.
After meeting in Washington, the committee said its action "was taken to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies and of less accommodative financial conditions domestically.
"The recent changes in the global economy and adjustments in U.S. financial markets mean that a slightly lower federal funds rate should now be consistent with keeping inflation low and sustaining economic growth going forward," it said.
Sung Won Sohn, chief economist at Norwest Corp., Minneapolis, said the move "is not meant to stimulate the U.S. economy. It is designed more for peace of mind. It will help frayed nerves in international financial markets in the wake of the hedge fund bailout and economic turmoil around the globe."
The Norwest economist and most others predicted Tuesday's rate cut was just the first installment in a series of reductions likely over the coming months.
"The Fed's first rate move after a policy change is almost never its last," said economist and money manager A. Gary Shilling, whose firm is based in Springfield, N.J. "The guess here is that there are more to come, barring an enormous stock market rally."
Edward Yardeni, chief economist at Deutsche Bank Securities, New York, noted that the fund rate has recently been more than a full percentage point above the next-shortest maturity, the three-month Treasury bill rate. "The Fed is behind the easing curve," he said.
Indeed, the 30-year Treasury "long bond" yield has been below the funds rate, pushed down as global investors have sought security from economic instability elsewhere. The result has been a flattened, and lately inverted, yield curve.
That has customarily signaled a turn toward more difficult business conditions, especially in the financial sector.
Last week the Federal Reserve Bank of New York brokered a rescue effort for Long-Term Capital Management LP of Greenwich, Conn. after the fund suffered huge reverses because of market disarray.
"The Fed's concern about the financial system was underlined by its role arranging a temporary lifeline for Long-Term Capital Management. Its involvement communicated the gravity of the risks to financial system the Fed perceived," according to economist Mickey D. Levy of NationsBanc Montgomery Securities in New York.
The federal funds rate, changed Tuesday, is the wholesale loan rate - that is, the price among banks for overnight loans of excess reserves. The Fed's own lending rate, the discount rate, which it charges banks for member loans, was left unchanged at 5%.
The Open Market Committee next meets Nov. 17.
