Federal Reserve affected by economy

WASHINGTON - The Federal Reserve, faced with an economy that went from bad to worse after the terror attacks, cut a key interest rate yesterday by a half-point, driving it down to a level not seen since 1962.

The rate cut, the ninth this year, is aimed at getting consumers and businesses - whose confidence has been badly shaken by the Sept. 11 attacks - to spend and invest to keep the economy from becoming even weaker.

After a closed-door meeting, Federal Reserve Chairman Alan Greenspan and his colleagues announced they were cutting the target for the federal funds rates, the interest banks charge each other on overnight loans, to 2.50 percent, the lowest level since May 1962.

In response, JP Morgan Guaranty, Chase Manhattan and Bank of America were among the commercial banks reducing their prime lending rates, the benchmark for millions of consumer and business loans, by a half-point to 5.50 percent, the lowest since Oct. 3, 1972, when the prime rate matched that level.

On Wall Street, stocks rose in a last-minute rally that overcame investors' initially lukewarm response to the Fed's action. The Dow Jones industrial average closed up 113.76 points at 8,950.59, according to preliminary calculations. Nasdaq, meanwhile, rose 11.83 points to 1,492.29.

"The terrorist attacks have significantly heightened uncertainty in an economy that was already weak," the Fed's chief policy-making group, the Federal Open Market Committee, said in a statement.

"Business and household spending as a consequence are being further dampened," the Fed added.

In the part of the Fed's statement that reflects possible future action, policy-makers maintained that their chief concern is the weak economy, leaving the door open to further interest-rate reductions.

"The risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future," the Fed said. Still, policy-makers said the long-term prospects for the economy remain favorable.

Wells Fargo chief economist Sung Won Sohn said the Fed is "setting the stage for an eventual economic rebound hopefully sometime next year. So by saying that the long-term economic outlook is good, the Fed is hoping that we are more likely to go out and buy things, fly on an airplanes and purchase stocks."

The Fed also cut its discount rate, the interest that the Fed charges to make direct loans to banks, by a half-point to 2 percent, matching the level in Nov. 6, 1958.

Before the attacks, consumers, whose spending accounts for two-thirds of all economic activity, were a key force keeping the economy afloat. Much of the economy's weakness has come from businesses sharply cutting capital spending. Economists now worry that consumers will close their pocketbooks and companies will trim spending even more.

In the aftermath of the attacks, consumer confidence has plunged by the largest amount since the 1991 Persian Gulf War - billions of dollars worth of business have been lost and layoffs have rocketed to a nine-year high.

The Fed's last rate cut of a half-point came on Sept. 17 in a between-meetings move the morning the stock markets reopened after a four-day shutdown.

The rate reductions, analysts said, probably won't prevent the economy from tipping into recession this year but they may keep a downturn from being prolonged.

Given the economic fallout from the attacks, many economists believe a recession is now unavoidable. The economy, as measured by the gross domestic product, barely grew in the second quarter, expanding at a rate of just 0.3 percent, the weakest performance in more than eight years.

Many analysts are predicting the second quarter will turn out to be the last quarter of economic growth this year.

The Blue Chip Economic Indicators consensus expects the GDP to shrink by 0.5 percent in the July-September quarter and decline by 0.7 percent in the final three months of the year before returning to growth early next year. A recession is commonly defined as two consecutive quarters of declining GDP.

And, President Bush's chief economic adviser said yesterday there is a high probability the U.S. economy will have two consecutive quarters of negative economic growth, one of the first times a top administration official has forecast the first downturn since the last recession in 1990-91.

"The short-term outlook is not good ...(but) with prudent decisions by Congress and the administration, there's every reason to believe a recovery would commence in 2002," said R. Glenn Hubbard, chairman of the Council of Economic Advisers.

Even if the country does suffer a recession, most analysts are looking for a rebound at least by the second half of next year, fueled by the Fed rate cuts, tax reductions and increased government spending.

The Bush administration is preparing a new economic stimulus package that will include extra spending and tax relief for individuals and businesses.