Fed Cuts Rates 0.75 Percent, Sparking a Stock Rally

WASHINGTON — The Federal Reserve, trying to light a fire under a cooling economy, cut short-term interest rates again on Tuesday and sparked a stock market rally.

While the 0.75-percent cut was less than some borrowers had wanted, it was more than enough to cheer stock investors. The Dow Jones average of industrial stocks jumped 420.41 points to 12392.66, a gain of 3.5 percent.

The Fed's policy makers have now lowered the federal funds rate, which banks charge each other for loans, six straight times over six months, driving it down to 2.25 percent from 5.25 percent.

Major banks quickly cut the prime interest rate by three-quarters of a percentage point to 5.25 percent. Banks charge their best business customers the prime rate, and use it as a peg for setting interest rates on home-equity loans, credit cards, car loans and more.

The Fed not only pushed down its benchmark rate to the lowest point since late 2004, but they also cut the discount rate by 0.75 percent to 2.5 percent. That's the rate the Fed charges banks and brokers that borrow directly from it.

There was more dissent than usual among the Fed officials, with two of the 10 Federal Open Market Committee members saying they preferred a smaller rate cut.

In a statement accompanying its decision, the committee said the "outlook for economic activity has weakened further" and warned that "the tightening of the credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters."

For months, the financial markets have been in danger of freezing up as record numbers of loans — particularly subprime home mortgages — slipped into default. Those bad loans have made financial institutions reluctant to keep lending. When the Fed lowers interest rates, it encourages lenders to get back in the game.

An easier credit environment could help the housing sector, which has been taking a beating for more than two years. Fresh evidence of that industry's troubles came in a Census Bureau report showing construction of single-family homes fell 6.7 percent in February from the previous month. The annual rate of 707,000 units was the lowest since January 1991.

Even though lower interest rates can help stimulate housing, the Fed policy makers held back from cutting a full percentage point – as many borrowers had hoped — because they are worried about inflation. Lower interest rates tend to weaken the dollar's value as international investors seek better returns elsewhere, and a weak dollar makes it more expensive to purchase oil, clothes, foods and other products made overseas.

In its statement, the Fed said: "Inflation has been elevated, and some indicators of inflation expectations have risen." It added that it will "monitor inflation developments carefully."

A Labor Department report released Tuesday showed that wholesale prices for finished goods rose 0.3 percent in February, largely because gasoline and natural gas prices moved higher. That means consumer inflation could rise as the producer prices ripple out in coming months.

The Fed has been under tremendous pressure in recent weeks to take bold steps. Besides cutting interest rates, it has for the first time opened its "discount window" for direct loans to major investment houses. In recent days, it engineered a Wall Street rescue by putting a $30 billion line of credit behind the sale of Bear Stearns Companies Inc. to another New York investment bank, JPMorgan Chase & Co.

Harvey Snider, first vice president of investments at a Merrill Lynch & Co.'s office in suburban Atlanta, praised the Fed's action Tuesday. "We've got to get the economy going ... and lowering the price of money is a step in the right direction," he said.

Bernard Baumohl, managing director of the Economic Outlook Group LLC, said in a written assessment that because of the Fed's "aggressive actions," the country is "now approaching a bottom in the housing cycle." He said a robust recovery is "still several quarters away," but conditions will improve as the credit crunch eases.

President Bush, while speaking on trade policy during a visit to Jacksonville, Fla., said his administration and the Fed are showing "leadership" on the economy, and closely monitoring financial markets.

"If there needs to be further action, we'll take it, in a way that does not damage the long-term health of our economy," he said. "In the long run, Americans ought to have confidence in our economy."