The Fed’s Decision is In: What Does It Mean?

Just over an hour ago, the Fed — for the first tim...

Just over an hour ago, the Fed — for the first time since 2003 — cut its benchmark interest rate by a half-percentage point to 4.75 percent.

The rate on direct loans to banks was also lowered by half a percentage point to 5.25 percent.

And yes, for weeks analysts have been anticipating a cut would happen. However, many thought it would only be a quarter of a point — and the Fed had warned it would not act to bail out investors who had overextended themselves. Nothing was certain.

Taking all that into account — and given that this is the first cut in several years, and that throughout 2007, despite the housing crisis, the Fed had maintained it was better to keep the rate as is — this is pretty big news.

The Fed had good reason to take action. For one, inflation, which the Fed has said it viewed as its foremost concern — part of the reason the housing crunch ended up on the back burner — isn’t posing as dire a threat as earlier anticipated, according to the Labor Department, who reported Tuesday its producer price index, a measure of wholesale inflation, had its sharpest drop in 10 months in August.

But even if the good inflation news hadn’t been released Tuesday, it’s likely the Fed still would have lowered the interest rate due to market changes.

As the Federal Open Market Committee said today, the change came about as "developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook."

"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 Fed said in a statement. "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."

That’s a marked change in attitude from the Fed, who had previously de-emphasized the housing decline and resulting credit crunch — but both have indeed worsened, along with unemployment, since the Fed last met.

In addition, the whole mess has all shown global repercussions in other countries’ financial markets.

But what does this all mean for the economy?

The immediate effects:

  • The dollar fell to a new low against the euro, $1.3980 today.
  • Major U.S. stock indexes rose sharply right after the announcement, according to BusinessWeek.

Potential changes in the near future include:

  • Banks were expected to immediately cut the prime rate, base rate for many business and consumer loans, such as home equity lines of credit and credit cards, from 8.25% to 7.75%, according to USA Today.
  • Adjustable-rate mortgage rates could possibly fall, but the impact today’s announcement will have on ARMs may not be large as they are also based on other interest rates. (Since Treasury yields affect fixed mortgage rates, the cut will likely have less of an effect on 30-year-mortgage holders, USA Today says.)

Today’s news pleased many in the housing market. But of course, the housing crisis is far from over.

This is, in fact, quite a big week for U.S. Federal Reserve Chairman Ben Bernanke: On Thursday, he will testify about the current mortgage situation to a House Financial Services Committee. The committee members have made several suggestions — some in opposition to Bernanke’s assessments — about how to correct the situation, reports.

What will they suggest? How will Bernanke defend the Fed’s previous and recent policy decisions? Stay tuned to MHN Out and About for continued coverage.