As credit crisis festers, Fed set to cut rates

The U.S. Federal Reserve is widely expected to cut interest rates on Tuesday by at least a quarter-percentage point to fortify the economy against a credit crunch and housing slump that some economists fear could bring a recession.

Steady if unspectacular hiring and signs the consumer has yet to fold suggest the economy, while cooling, has not entered a precipitous slide. At the same time, deteriorating conditions in financial markets recently led the Fed to make clear it saw risks rising and was ready to respond.

"They now believe the dysfunctional credit markets present more risk to the economy and the financial system than anything found in the economic or inflation statistics," economists at financial services giant Wachovia wrote in a note to clients.

"For the time being, the Fed will focus on righting the financial markets and making sure there is enough stimulus in place to offset the tightening in credit markets and ongoing unraveling of the housing market," they said.

The U.S. central bank meets against a backdrop of widespread unease over the sagging housing market and deepening gloom over exposure to delinquent mortgages at major financial institutions around the world.

Financial markets are betting the Fed lowers the benchmark federal funds rate by a quarter-percentage point to 4.25 percent from its current level at 4.50 percent, and think a surprise half-point reduction is not out of the question.

At its last meeting on Oct. 30-31, the central bank lowered rates by a quarter point, following up a surprisingly large half-point reduction in September. At the time, the October easing was "a close call," minutes of the meeting released later said, because evidence of a pronounced weakening of the broader economy was not evident to all policy-makers.

RIVERS OF RED INK

But since that decision, money center banks like Citigroup, Bank of America, and HSBC have announced billions of dollars worth of write-downs due to exposures to subprime mortgages. As financial market angst has spread over the extent of subprime problems, credit availability has stiffened, fueling heightened worry at the Fed.

"These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors," Fed Chairman Ben Bernanke said on Nov. 29.

So far, outside of the housing and financial services sectors, the U.S. economy has exhibited resilience. In addition to a steady labor market, many retailers reported stronger-than-expected November sales and a slumping dollar helped boost demand for U.S. exports.

Read Complete Story