Fed Cuts Rate What Now ?

WASHINGTON, Sept. 18 — The Federal Reserve today lowered its benchmark interest rate by a half point, a forceful policy shift intended to limit the damage to the economy from the recent disorder in the housing and credit markets.

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While an interest rate cut was widely expected, there had been profound uncertainty about whether the Fed would choose a more cautious quarter-point reduction. But the bolder action and an accompanying statement, both approved by a unanimous vote of the central bank’s policy-setting committee, made it clear that the Fed had decided the risks of a recession were too big to ignore.

“Developments in financial markets since the committee’s last regular meeting have increased the uncertainty surrounding the economic outlook,” the central bank said. Signaling that it might cut rates more if necessary in months ahead, it said it would “continue to assess” the economic outlook and “act as needed to foster price stability and sustainable economic growth.”

The decision, which reset the overnight lending rate between banks to 4.75 percent, was the Fed’s first rate cut in four years.

Stocks immediately soared. The Dow Jones industrial average registered its biggest one-day gain in almost five years, closing at 13,739.39, up 335.97, or 2.5 percent. The Standard & Poor’s 500-stock index rose nearly 3 percent.

For consumers, the Fed’s move could mean lower borrowing costs on for mortgages and automobile loans. But the impact may be muted, because investors remain deeply anxious about the credit quality of mortgages and other long-term loans. The main problem in the past month has not been high rates so much as the availability of capital to complete deals.

In a separate move to bolster the banking system, the Fed also said today that it had cut its discount lending rate, which applies to short-term emergency loans to banks, to 5.25 percent — also a half-point cut.

This was the Federal Reserve’s most abrupt reversal of course since January 2001, when it suddenly slashed rates at an unscheduled emergency meeting because of signs that the economy was slipping into a recession. The last half-point cut in the federal funds rate came in November 2002.

Economists said that the Fed’s move today was similarly pre-emptive. “Monetary policy makers are worried about growth being seriously compromised and are prepared to take whatever prudent steps they can to avoid a deep slump,” said Joshua Shapiro, chief United States economist for MFR.

Some aspects of today’s Fed’s move could fuel inflation fears. Gold, a traditional investment safe haven in times of inflation, soared immediately after the Fed’s decision was announced. As United States interest rates became less attractive for investment, the value of the dollar against the euro touched a new low before recovering slightly, and oil prices continued to climb even further above $80 a barrel.

In the stock market, financial stocks posted the biggest gains, reflecting the fact that banks now will face lower borrowing costs, which should help drive profits higher.

“Shock therapy,” was the assessment of Ethan Harris, chief economist at Lehman Brothers.

But Mr. Harris cautioned that the Fed stopped short of signaling a firm commitment to more rate reductions. While it dropped its previous statement that inflation was still the “predominant concern,” which would argue against using lower rates to stimulate the economy, the Fed said that “inflation risks remain” and that it would “monitor inflation developments carefully.”

David Rosenberg, chief North American economist at Merrill Lynch, said the Fed appeared deliberately ambiguous about its readiness to cut rates even further at its policy meetings in October and December.

“The Fed kept its cards much closer to its vest than anyone would have guessed,” Mr. Rosenberg said. “It’s not at all clear they think they have more to do.”

As recently as six weeks ago, the central bank was still predicting “modest” growth for the economy and warning that inflation remained its “predominant concern.” As in 2001, the Fed’s move today came after a panic in financial markets and the collapse of a speculative bubble. This time, the panic is in credit markets spooked by dubious mortgages on inflated housing prices. Back then, it was the stock market that crashed, initially because the air went out of inflated dot-com stocks.