Evidence of an economic rebound - strong numbers in retail sales and consumer sentiment - over the last few sessions had cast doubt on whether the Fed would cut by the expected 50 basis points. But the Federal Reserve apparently believes that a lowering of another half percentage point is needed to pump up a deflated economy. Tuesday's rate cut is the fifth so far this year, bringing the key Fed funds down 2.5 percentage points, to a rate of 4% - the lowest in seven years. The discount rate was also lowered by 50 basis points to 3.5%.
The wording of the Federal Reserve's policy statement suggests that the central bank is not yet ready to end the current easing cycle and move to a neutral bias on monetary policy. Future rate cuts are not out of the question. In fact, the Fed's statement is extremely cautious, noting a lack of improvement in capital spending, a continuing squeeze on profitability, and the uncertain business outlook. All these factors "seem likely to hold down capital spending going forward. This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy."
"This is a more favorable statement than I had expected in the sense of generating further rate cuts," says David Wyss, chief economist at Standard & Poor's. "They don't want a recession. So they would rather make a mistake and have too much growth instead of too little."
For now the Fed is not overly concerned with signs of inflationary pressure. "With pressures on labor and product markets easing, inflation is expected to remain contained," the Fed says. Wyss cautions that the inflation seen in energy prices has not spread, but "given unit labor cost increase, I'm not sure the Fed can ignore it quite as much."
Among Tuesday's stocks in the news, the world's biggest retailer, Wal-Mart Stores Inc. (WMT
), said first-quarter earnings rose 4%, in line with lowered expectations, as a slower consumer spending hurt profit growth.
The rate cut was apparently factored into the market already. The Dow Jones Industrial Average lost just 3.95 points, or 0.04%, to 10,873.38. The Nasdaq Composite index added 25.64 points, or 1.23%, to 2,107.56. Meanwhile, the broader S&P 500 gained 3.25 points, or 0.26%, to 1,252.17.
U.S. Treasuries were trading off after the Fed said it would lower interest rates by 50 basis points.
In economic data Tuesday, the Redbook retail sales report showed a gain of 0.5% for the week ended May 12. This was slower than the 0.8% gain reported for the last period, according to its weekly survey. The report added that sales were on or below plan for most retailers, though the Mother's Day holiday increased sales of cosmetics, accessories, and jewelry.
European markets were trading higher, after selling off on Monday. London's Financial Times-Stock Exchange 100 index ended up 152.40 points, or 2.68%, to 5,842.90. Germany's DAX Index added 5.70 points, or 0.09%, to 6,070.38. In Paris, the CAC 40 gained 56.41 points, or 1.03%, to 5,544.13.
Asian markets ended mixed. Japan's Nikkei 225 index advanced 181.01 points, or 1.30%, to 14,054.03. In Hong Kong, the Hang Seng index lost 9.08 points, or 0.07%, to 13,250.09.
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