WASHINGTON – The Federal Reserve Board today cut the interest rate it charges on direct loans to banks, paring the discount rate by 0.5 percentage points to 5.75 percent. The unexpected action was intended “to promote the restoration of orderly conditions in financial markets,” the Fed said in its announcement.
The rate cut was one of two “temporary changes … to the Reserve Banks’ usual practices” announced by the Fed this morning. The other will allow term financing on discount-window loans for up to 30 days, renewable by the borrower, although existing collateral requirements will be maintained.
Both changes “will remain in place until the Federal Reserve determines that market liquidity has improved materially,” the announcement said.
(The benchmark federal funds rate remains unchanged at 5.25 percent.)
The changes – decided during a conference call yesterday evening among members of the Federal Open Market Committee – were requested by the boards of directors of the Federal Reserve Banks of New York and San Francisco. The Fed said they “are designed to provide depositories with greater assurance about the cost and availability of funding.”
Not since 2001 had the central bank acted to cut interest rates outside a regular meeting of the policymaking FOMC, according to Bloomberg News. The committee said in a statement issued in Washington that it was “prepared to act as needed to mitigate the adverse effects on the economy arising from disruptions in financial markets.”
“Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth,” the FOMC said in the statement. “The downside risks have increased appreciably.”
The cut in the discount rate “will basically do more to unclog the credit channels than a fed funds rate cut would have,” Drew Matus, senior economist at Lehman Brothers Holdings Inc. in New York and a former Fed employee, told Bloomberg News. “I think it was exactly the right thing to do.”
Investors appeared to agree. U.S. stock markets rallied on the news, with the Standard & Poor’s 500 index gaining 0.8 percent to 1,4322.25 points at 10:50 a.m., Bloomberg said.
Additional information on the Federal Reserve and today’s action is available at www.federalreserve.gov.