The Federal Reserve today cut 75 basis points from two key short-term interest rates — a move that in less turbulent times would have been viewed as a drastic measure, but which fell short of some investors’ expectations for a full 1 percent cut.

The Fed’s actions fueled a stock market rally, but aren’t expected to have an impact on long-term interest rates like mortgages until investors who fund loans return to the secondary market where they are bought and sold.

The decision by the Fed’s Open Market Committee to lower its target for the federal funds overnight rate from 3 percent to 2.25 percent — and to cut the discount rate to 2.5 percent — makes money available more cheaply to banks and financial institutions.

The Fed has now cut its target for the federal funds rate — the rate banks charge each other to lend money overnight — six times since September, when it stood at 5.25 percent.

In a statement, the committee said that financial markets "remain under considerable stress," but that worries about inflation precluded an even larger, 100-basis-point reduction that some investors had been betting on. One basis point is a hundredth of a percent.

"Inflation has been elevated, and some indicators of inflation expectations have risen," the committee said. While inflation is expected to moderate in coming quarters, the committee warned that "it will be necessary to continue to monitor inflation developments carefully."

The committee’s inflation warning may have reduced expectations for future drastic cuts in short-term interest rates, and fears about inflation could translate into higher mortgage rates. But the Fed has introduced several other measures intended to provide liquidity to banks and financial institutions and help ease the credit crunch.

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Faucher thinks that if the Fed said, "We’re going to put some money on the table," investors would be reassured, "and it could turn out to be the case that the government doesn’t need to actually spend that money."

Because they have had so little impact on lending or the economy itself, Faucher doesn’t see the Fed’s short-term interest-rate cuts as harmful, either.

Some observers worry that short-term rate cuts will weaken the dollar, push up the price of oil and other commodities, and fuel inflation — which would in turn drive up yields on long-term investments like Treasurys and mortgage-backed securities.

So far, the short-term rate cuts — intended to grow the economy by encouraging businesses to borrow — are not having much impact on inflation, "because they are not having much impact on the economy," Faucher said. "The Fed can cut, but if the lenders are not willing to lend it doesn’t make any difference."

That’s a view shared by the California Association of Realtors’ economist, Leslie Appleton-Young.

"If people expect a lot of inflation in the future, that long rate is going to be higher," Appleton-Young said. "The problem with the markets right now is they are not operating. This is just absolutely unprecedented. So if the Fed lowers (short-term rates), I think that’s great, they are trying to boost confidence."

***

What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

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