Fed Lowers Rate to 4.75 Percent, First Cut Since 2003 (Update6)

By Scott Lanman and Craig Torres

Sept. 18 (Bloomberg) -- The Federal Reserve lowered its benchmark interest rate by a half point to 4.75 percent, the first cut in four years, to protect the U.S. from sinking into a recession sparked by fallout from the housing-market collapse.

``Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets,'' the Federal Open Market Committee said in a statement after meeting today in Washington. The central bank will ``act as needed to foster price stability and sustainable economic growth.''

Stocks surged, two-year Treasury notes rose and the dollar fell to a record low against the euro. The larger-than-forecast reduction suggests Chairman Ben S. Bernanke is prepared to leave himself open to criticism that he's rescuing investors from bad decisions for the sake of saving the six-year expansion.

``You forget about everything else, and you have to make sure the worst-case doesn't happen,'' said Stephen Cecchetti, a former New York Fed research director who is now a professor at Brandeis University in Waltham, Massachusetts. ``This is very forward-looking.''

Core inflation has improved ``modestly'' this year, while some risks remain, the Fed said. The decision was unanimous.

``Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction, and to restrain economic growth more generally,'' the FOMC said.

Adhering to Schedule

The decision is also a sign that policy makers don't want to cut rates between their regular meetings, Cecchetti said. Policy makers next gather Oct. 30-31. Traders repeatedly speculated on an unscheduled rate announcement in the past month.

The federal funds rate, which banks charge each other for loans, had stood at 5.25 percent since June 2006. That's when the Fed ended a two-year run of increases that lifted the rate from a four-decade low of 1 percent.

Most economists anticipated a quarter-point, and traders had pared bets on a bigger move in recent days as some Fed officials signaled they would be reluctant to back a half-point cut.

``Clearly they are trying to be preemptive,'' said Paul Kasriel, chief economist at Northern Trust Co. in Chicago and a former Fed economist. At the same time, the inflation language suggests that officials are ``trying to increase their options at upcoming meetings,'' he said.

Discount Rate

The Fed's Board of Governors also lowered the rate on direct loans to banks by half a percentage point to 5.25 percent.

The Fed first reduced the so-called discount rate by a half point on Aug. 17 in a surprise move to restore confidence after some companies found it hard to obtain funds as investors fled riskier assets. The credit crunch was caused by losses in securities tied to subprime mortgages.

It was the first time in almost five years that the Fed move differed from analysts' predictions. The half-point reduction in the federal funds target was forecast by 23 of 134 economists surveyed by Bloomberg News. One hundred and five predicted a reduction of 25 basis points, while six forecast no change. A basis point is one-hundredth of a percentage point.

The Standard & Poor's 500 Index climbed 2.9 percent, the biggest gain since March 2003. The Fed last cut the federal funds target in June 2003, to 1 percent from 1.25 percent. Meantime, crude oil climbed to a record and gold and copper surged.

Traders expect the Fed to reduce the benchmark rate to 4.25 percent by the end of 2007, compared with a forecast of 4.5 percent yesterday, based on futures prices.

Protecting Lenders

Today's move suggests Bernanke's comment on Aug. 31 that it's not the Fed's responsibility ``to protect lenders and investors from the consequences of their financial decisions'' may be little more than talk for now, said Neal Soss, chief economist at Credit Suisse in New York.

``This concern about moral hazard is a whole lot easier to preach than it is to implement,'' said Soss. ``It's very hard to administer tough love.''

Investors began anticipating a reduction on Aug. 9, a week before the Fed made the initial discount-rate cut and said risks to growth have ``increased appreciably.'' Two weeks later, Bernanke said in a speech that the central bank would ``act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.''

Shifting Focus

Policy makers were forced to shift their focus to growth from inflation in August as rising defaults on subprime mortgages rippled through global credit markets. Asset-backed commercial paper contracted by the most in at least seven years and Countrywide Financial Corp., the biggest U.S. mortgage company, was shut out of the market.

The decision comes two days before Bernanke faces lawmakers in a House Financial Services Committee hearing on the mortgage- market crisis. Representative Barney Frank, the Massachusetts Democrat who heads the panel, on Sept. 7 called for a ``meaningful'' rate cut by the Fed.

Today, Frank said he was ``pleased'' with the rate reduction yet ``surprised'' that, in his judgment, the Fed's ``continued concern about inflationary risk outweighs what I believe to be growing risks to sustained growth.''

Separately, House Speaker Nancy Pelosi said the Fed move ``underscores the economic insecurity that middle-class Americans have long been feeling.'' The California Democrat said in a statement that she hopes the rate cut ``will bring some relief to the middle class.''

Economic reports show that the deepening recession in housing is taking a toll on the broader economy. The Labor Department said Sept. 7 that employers cut 4,000 workers in August. Job growth has been slowing since June, Atlanta Fed President Dennis Lockhart acknowledged. August figures for retail sales and industrial production were below economists' forecasts.

Highlighting Risks

Officials including Fed Governor Frederic Mishkin and San Francisco Fed President Janet Yellen highlighted the risks to spending in speeches this month. Teams of Fed economists also ran what-if scenarios to supplement the central forecast given to the FOMC members today.

Inflation has also receded. The Fed's preferred price gauge, which excludes food and energy costs, rose 1.9 percent from a year earlier in July, within the 1 percent to 2 percent comfort range stated by several officials. The Labor Department said today that producer prices fell 1.4 percent in August, more than economists predicted.

Policy makers including Philadelphia Fed President Charles Plosser and Richard Fisher of the Dallas Fed signaled they were less likely to support a half-point cut this month. Plosser said Sept. 8 that he had not made up his mind on rates. Neither has a vote on the FOMC this year.

``Lowering the funds rate overall doesn't boost housing,'' said Lee Hoskins, a former Cleveland Fed president and now senior fellow at the Pacific Research Institute in San Francisco. ``All this does is delay the day in which these wealth losses will finally be worked out in the marketplace, so I don't regard this as a particularly good move.''

U.S. Federal Open Market Committee Statement: Text

By Washington newsroom +1-202-624-1820

Sept. 18 (Bloomberg) -- The following is the full text of the statement released today by the Federal Reserve:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4 3/4 percent.

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Developments in financial markets since the Committee's last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Charles L. Evans; William Poole; Eric S. Rosengren; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50 basis point decrease in the discount rate to 5 1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve banks of Boston, New York, Cleveland, St. Louis, Minneapolis, Kansas City and San Francisco.

U.S. Producer Price Index Drops More Than Forecast (Update3)

By Courtney Schlisserman

Sept. 18 (Bloomberg) -- Prices paid to U.S. producers fell more than forecast in August, diminishing concern over inflation as the Federal Reserve considers lowering interest rates. The 1.4 percent decrease, the biggest since October, followed a 0.6 percent increase in July, the Labor Department said today in Washington. So-called core prices, which exclude fuel and food costs, rose 0.2 percent after a 0.1 percent gain the month before.

Slower inflation gives policy makers more room to cut their benchmark rate today in an effort to sustain the expansion in the face of a housing recession. A drop in fuel expenses pushed prices down in August and slacker economic growth will continue to restrain raw-material costs, economists said.

The Fed ``can point to reasonably good news on inflation,'' said Peter Kretzmer, a senior economist at Banc of America Securities LLC in New York, who accurately forecast the core rate. ``The weakness in the economy is making it difficult for companies to pass along increases. That bodes very well'' for inflation in coming months, he said.

The producer-price report is the second of three monthly inflation gauges. The government said on Sept. 14 that import prices dropped 0.3 percent in August, the first decline in seven months. Figures for consumer prices will be issued tomorrow.

Central Bank `Luxury'

``There is little residual inflation pressure in the U.S. economy,'' said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. ``The fact that most measures of core inflation have shown tame readings as of late gives the Fed the luxury of cutting rates aggressively if need be.''

The Fed cut the rate on loans to banks on Aug. 17 as global stock markets slumped on concern damage from rising mortgage defaults was spreading. At the time, policy makers dropped language indicating their bias toward fighting inflation and instead highlighted a rising threat to economic growth.

The Federal Open Market Committee will announce its decision at about 2:15 p.m. in Washington.

The yield on U.S. Treasury securities rose following the report. The yield on the benchmark 10-year note was 4.49 percent at 9:45 a.m., compared with 4.47 percent late yesterday.

Exceeding Estimates

Economists forecast producer prices would decline 0.3 percent after a 0.6 percent increase, according to the median of 76 projections in a Bloomberg News survey. Core prices were expected to rise 0.1 percent.

Over the past 12 months, producer prices rose 2.2 percent, down from a 4 percent increase in July. The year-over-year increase in costs excluding food and energy also eased to 2.2 percent compared with 2.3 percent in July.

A separate report from the Treasury Department showed foreign buying of U.S. securities slowed in July to the weakest pace in seven months as a rout in the subprime mortgage market sapped demand for American bonds.

Total holdings of equities, notes and bonds rose a net $19.2 billion, from a revised $97.3 billion in June.

Economists almost universally forecast the Fed will cut the benchmark overnight lending rate between banks for the first time since 2003. The median calls for a quarter-point cut to 5 percent.

Energy Expenses

The drop in wholesale prices last month was led by a 6.6 percent decline in energy costs that was the biggest since April 2003. Costs for gasoline, natural gas, heating oil and diesel fuel all fell.

Costs of intermediate goods, such as steel used in earlier stages of production, fell 1.2 percent in August, after a 0.6 percent increase the prior month. They were up 2.4 percent from a year ago.

Excluding food and energy, intermediate prices fell 0.5 percent and were up 2.4 percent from August 2006.

Prices for raw materials, or so-called crude goods, dropped 3 percent.

The cost of consumer goods fell 1.8 percent as food charges fell and prices for capital goods rose 0.1 percent.

Faced with the prospect of an economic slowdown, some companies are lowering prices to stoke demand ahead of the key holiday-spending season in the last three months of the year. Apple Inc. Chief Executive Officer Steve Jobs earlier this month cut the price of the iPhone by $200 to boost sales. The calendar fourth quarter and the back-to-school season that just ended are Apple's two busiest periods.

Price Increases

Others are suffering from increases in commodity costs and are boosting prices as a result.

``We've already raised prices and have more planned,'' Sara Lee Corp. Chief Executive Officer Brenda Barnes told analysts last week. ``We are certainly facing these headwinds of increased commodity costs, some of them at unprecedented levels, like wheat.''

Sara Lee fell $10 million short of covering the jump in raw-material costs, even after raising prices on bread and coffee, Barnes said.

Bernanke Weighs Recession Risk Against Bailout Charge (Update2)

By Steve Matthews

Sept. 18 (Bloomberg) -- The Federal Reserve will probably cut its benchmark interest rate today for the first time in four years, seeking insurance against a recession. The main question is how big a policy Chairman Ben S. Bernanke is ready to buy.

While a quarter-point reduction in the federal funds rate may not be enough to bolster growth and investor confidence, a half-point cut might fan inflation and be perceived as giving in to pressure from Wall Street firms that made bad bets, especially in the market for securities backed by subprime mortgages.

Bernanke and fellow policy makers ``are really caught,'' said Robert Eisenbeis, a former research director at the Fed's bank in Atlanta who attended meetings of the rate-setting Federal Open Market Committee before retiring early this year. ``The Fed needs to avoid the perception of bailing out the markets, lenders or borrowers.''

The FOMC will opt today for a quarter-point cut to 5 percent in the rate that banks charge each other for overnight loans, according to the median prediction of 134 economists surveyed by Bloomberg News. Twenty-three of the forecasters projected a half-point move, which traders think is coming sooner or later: Interest-rate futures indicate a rate of 4.5 percent by year-end. The decision is scheduled for about 2:15 p.m. in Washington. The gathering convened at 8:30 a.m.

Most-Analyzed Statement

Whatever today's decision, the statement accompanying it may be the most-analyzed in years. Reports portray a weakening economy: The Labor Department said Sept. 7 that that the U.S. last month suffered its first job losses since 2003. Investors will look for hints of further cuts -- such as a pledge to act as needed to safeguard the six-year expansion -- or language that plays down the risk of higher inflation.

``The markets will be disappointed by 25 basis points,'' said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. ``If they do more now, they may be more cautiously optimistic in the statement. If they do 25 basis points, they will commit to doing more. You can argue it either way for which is the more powerful.''

The Fed's decision today will come hours after a government report that showed wholesale prices fell 1.4 percent in August, more than forecast. The Consumer Price Index is released tomorrow. As recently as the last FOMC meeting Aug. 7, officials said inflation was the ``predominant'' risk to the U.S. economy.

Just 10 days later, the Fed acknowledged that ``downside risks to growth have increased appreciably'' and pledged to ``act as needed.'' Policy makers will probably use similar language today, economists said.

`A Considerable Amount'

``The statement will point to the growth rate as the predominant policy influence and give the market the flexibility to price in a considerable amount of easing,'' said Brian Sack, vice president at Macroeconomic Advisers LLC in Washington and a former Fed economist.

Bernanke, 53, and his team may take additional steps to increase liquidity, including lowering the discount rate --which the fed charges on loans it makes to banks -- or altering terms for collateral used for loans from the central bank, economists said.

In their public comments, Fed officials have diverged in their assessments of risks to growth, making today's meeting particularly tough for analysts to handicap.

Since the August jobs report, Fed Governor Frederic Mishkin and San Francisco Fed President Janet Yellen have highlighted threats to consumer spending. By contrast, Fed bank Presidents Richard Fisher in Dallas and Charles Plosser in Philadelphia noted signs of resilience in the economy.

No Cave-In

At the same time, all agree the Fed doesn't want to be seen as caving in to funds that piled into the market for securities linked to subprime mortgages, those made to borrowers with poor or limited credit histories.

As defaults on such loans climbed, investors fled, making it tough for some companies to obtain credit; the market for asset-backed commercial paper shrank the most in at least seven years.

``It is not the responsibility of the Federal Reserve --nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions,'' Bernanke said in an Aug. 31 speech in Jackson Hole, Wyoming.

Anything seen as a bailout might increase ``moral hazard'' -- spurring investors to take on even more risk, comfortable in the belief the Fed will make good their losses.

Makes It `Worse'

``Every time the Fed turns around to save its friends on Wall Street, it makes the situation worse,'' Jim Rogers, the chairman of Beeland Interests Inc. who predicted the start of the global commodities rally in 1999, said in an interview from Shanghai. ``The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems in the U.S.'' if the Fed injects too much liquidity, he said.

Former officials including Alice Rivlin, who was a Fed vice chairman under Bernanke's predecessor Alan Greenspan, have expressed regret over cutting rates three times in 1998. The economy continued to expand with little harm from turmoil in financial markets at the time, data later showed.

``The moral hazard argument is a powerful one,'' said Philip Orlando, who helps manage $260 billion as chief equity market strategist at Federated Investors Inc. in New York. As a result, he predicted, ``the market is wont to be disappointed'' by today's decision.

Others say policy makers will focus more on the recent economic data showing signs of a sputtering economy. Besides the decline in August payrolls, retail sales and industrial production rose less than forecast last month, and the Commerce Department may say tomorrow that builders broke ground on the fewest new homes since 1995.

Bernanke and fellow policy makers ``are trying to step away from the Greenspan model,'' said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. ``But at the end of the day, they will act the same.''

U.K. Inflation Rate Falls to Lowest Since March 2006 (Update3)

By Brian Swint

Sept. 18 (Bloomberg) -- The U.K.'s inflation rate unexpectedly fell last month to the lowest level since March 2006, giving the Bank of England scope to reduce interest rates in response to any worsening of the credit-market rout.

Consumer prices rose 1.8 percent from a year earlier compared with 1.9 percent in July, the Office for National Statistics said today in London. Economists expected the rate to be unchanged, according to the median of 35 forecasts in a Bloomberg News survey. Inflation has slowed from a decade-high of 3.1 percent in March. Prices rose 0.4 percent compared with July.

The Bank of England, which signaled a month ago its benchmark interest rate may have to rise to curb inflation, is now facing an economy under threat from higher credit costs. Consumers are shouldering a record 1.3 trillion pounds ($2.6 trillion) in debt, a decade-long housing boom is cooling and the bank was last week forced to bail out mortgage lender Northern Rock Plc.

``The inflation picture has improved substantially over recent months,'' said George Buckley, chief U.K. economist at Deutsche Bank AG in London. ``With the crisis in the financial markets persisting, interest rates may well be cut earlier in 2008 than we expect.''

To ease a surge in overnight borrowing costs, the Bank of England today made 4.4 billion pounds in emergency funds to U.K. banks. The London interbank offered rate that banks charge each other for overnight loans in pounds dropped 33 basis points to 6.47 percent after the move.

Slower Growth?

The collapse of subprime mortgages in the U.S. has prompted lenders to hold back on loans to all but the safest borrowers. Customers of Northern Rock, the U.K.'s third-largest home-loan provider, today queued for a fourth day to withdraw their savings.

Slower inflation means the Bank of England may have scope to cut its benchmark rate from 5.75 percent if the credit rout continues. The central bank said Sept. 6 it expects inflation to stay around its 2 percent target in coming months, and Governor Mervyn King said six days later the turmoil may curb consumer prices and hurt economic growth.

The housing market is also showing signs of slowing. London house prices dropped the most in three years this month, a report from Rightmove Plc on Sept. 14 showed.

Reductions in mortgage exit fees and clothing prices led the slowdown in inflation, the statistics office said. Financial services costs declined 3 percent from a year earlier and prices in the clothing and footwear category dropped 3.5 percent. Food and beverage costs climbed 3 percent and an increase in ticket prices for live music and theater also spurred inflation.

Off the Agenda

The pound declined and traded at $1.9909 at 12:30 p.m. in London compared with $1.9950 before the report.

``A rate rise is now off the agenda,'' said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London. ``Inflation numbers should be helpful for the next few months.''

The Bank of England has so far proved itself more reluctant than the European Central Bank or the U.S. Federal Reserve to take action against the market slump.

The Fed may cut its benchmark rate by a quarter percentage point to 5 percent later today, a Bloomberg News survey showed, and the ECB has held seven special cash auctions for banks since Aug. 9. The U.K. central bank announced its second such move today.

Investors have responded to the market slump by slashing forecasts for the bank's benchmark rate. The implied rate on the June futures contract was 5.55 percent today, down from 5.84 percent a month ago. The contract settles to the three-month London interbank offered rate for the pound.

Next Move

``I really struggle to find a reason why the Bank of England could possibly hike again,'' Rob Carnell, an economist at ING Wholesale Banking, said in an interview. ``The next move will be a rate cut.''

Bank of England policy makers are nevertheless still concerned economic growth will allow companies to raise prices. The economy will expand 2.9 percent in 2007, the most in three years, the International Monetary Fund predicted July 25.

The retail price index, a gauge used by labor unions when making wage demands, rose 4.1 percent in August from a year earlier, the statistics office said today.

Raw material costs are also rising. Oil prices climbed to a record $81.24 a barrel today and global wheat prices surpassed $9 a bushel for the first time last month.

Premier Foods Plc, the U.K.'s biggest producer of cakes and instant soup, said Sept. 4 it sees a ``substantial inflationary environment on food.''

Yields on U.K. inflation-protected bonds suggest traders expect inflation in Europe's second-largest economy to accelerate. The yield on inflation-indexed debt due in 30 years was 3.48 percentage points lower than that on 30-year gilts today, a gap that represents the rate of inflation investors expect over the life of the securities.

``There are a lot of upstream price pressures,'' said Alan Clarke, an economist at BNP Paribas SA in London. ``But we see the bank lowering rates once the inflation risks are squeezed out.''