Blommberg reports:

June 25 (Bloomberg) — Federal Reserve policy makers reduced the benchmark U.S. interest rate to 1 percent, the lowest since Dwight Eisenhower was president 45 years ago, in an effort to boost the economy and ward off deflation.

Members of the Fed’s rate-setting Open Market Committee voted 11-1 to lower the overnight bank lending rate a quarter percentage point from 1.25 percent. The decline was less than the half-point cut some investors expected, and stock and bond prices fell.

“Recent signs point to a firming in spending, markedly improved financial conditions, and labor and product markets that are stabilizing,'’ the Fed said in a statement. “The economy, nonetheless, has yet to exhibit sustainable growth.'’

Chairman Alan Greenspan and the other central bankers cut the overnight bank lending rate for the 13th time since January 2001 to help lift an economy that has lost 324,000 jobs in six months and that grew at just a 1.9 percent annual rate last quarter. The so-called federal funds rate is now the lowest since it averaged 0.68 percent in July 1958.

The Fed said the risks to the economy “are roughly equal.'’ At the same time, “the probability, though minor, of an unwelcome substantial fall in inflation exceeds that of a pickup of inflation from its already low level,'’ the statement said. “On balance, the Committee believes that the latter concern is likely to predominate for the foreseeable future.'’

Fed’s Next Move

Greenspan has warned of possible “corrosive'’ effects from slowing inflation or from a broad decline in prices, called deflation, that might sap profits and change spending behavior.

Today’s statement delivers three basic messages, said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York, who correctly predicted the quarter-point cut. “One, things are getting better, slowly,'’ he said. “Two, the Fed is ready to ease again if the data don’t improve further in the near term. Three, they won’t be hiking anytime soon.'’

The Fed next meets to review rates in August. The last time the FOMC lowered the overnight rate was Nov. 6.

With expectations for inflation low, policy-makers said they “judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time.'’

U.S. Treasuries fell after the Fed cut rates less than the half-point reduction some traders expected. The 1 1/4 percent note due May 2005 fell more than 1/4 point to 99 31/32 at 4 p.m. in New York as its yield surged 16 basis points to 1.25 percent. The 3 5/8 percent note maturing in 2013 fell more than a point, pushing its yield up 14 basis points to 3.39 percent.

The Standard & Poor’s 500 Stock Index fell 8.1 points, or 0.8 percent.

Cost of Borrowing

Today’s rate cut will affect the cost of borrowing for everything from corporate bank loans to home mortgages and credit cards.

“The interest rate cut certainly can’t hurt,'’ said James Young, chief financial officer of Union Pacific Corp., the largest U.S. railroad owner. “I’m not as optimistic that it will actually turn around consumer demand. The real key here is job creation and getting a national energy policy. High energy costs are really a constraint on growth.'’

The central bank also reduced the cost of direct loans to commercial banks, a rate known as the discount rate. The so-called primary credit discount rate fell to 2 percent; a secondary rate for distressed banks fell to 2.5 percent.

All but 11 of the 157 economists and analysts surveyed by Bloomberg News expected today’s policy move. Of the total, 97 expected a 25 basis-point cut, 48 predicted 50 basis points and one split the difference at 37.5 basis points.

Fed Voters

Fed Bank of San Francisco President Robert Parry dissented from the decision, calling from a 50-basis point cut. His district is the largest, covering nine Western states and 26.9 million workers who account for a fifth of the nation’s total employment. The district includes four of the top 10 states with the highest unemployment rates: Oregon at 8.2 percent, Washington and Alaska at 7.3 percent, and California at 6.6 percent.

Jamie Stewart, acting president of the New York Fed Bank, voted with the majority today, standing in for William McDonough, the former president, who resigned earlier this month. The bank’s board of directors has not yet appointed a successor.

Buffeted by the Iraq war, accounting scandals, tepid business confidence, and job losses, the U.S. economy has been unable to maintain a steady, broadening pace of growth for the past six quarters.

The nation’s factories used only 74.3 percent of their capacity in May, down from an average use rate of 82.7 percent in the five years before the recession began.

Company Views

Some corporate officers said that the latest rate reduction, while welcome, won’t necessarily spur them to speed up their business plans.

“This is directed at businesses to build inventory and to generate employment'’ said Hal Upbin, chief executive officer of clothing maker Kellwood Co. “I don’t know personally a quarter is going to make a difference, but it’s better than not doing anything.'’

As for St. Louis-based Kellwood, the company’s lower borrowing cost after 13 rate cuts, “while very welcome, hasn’t been a factor in our decision-making process,'’ he said.

Business investment in equipment and software, a measure frequently cited by Fed officials, fell by $14.7 billion on an annualized basis, or 6.3 percent, in the first quarter. The economy lost 17,000 jobs in May and the national unemployment rate stands at 6.1 percent.

Deflation Risks

Fed officials are concerned that sluggish demand, excess capacity and falling prices for many goods and some services may conspire to increase deflationary expectations among business executives and consumers.

Greenspan described this process earlier this month as “an interactive corrosive force'’ that the Fed needed to insure against. His comments created some of the expectations for today’s rate cut.

Consumer prices, minus food and energy, rose 1.6 percent over the 12 months ending May, a rate analysts suggest is too low to keep the economy out of deflation in the event of some kind of economic shock.

The Fed’s action is aimed at ensuring that U.S., the world’s largest economy, continues to grow at a time when other major economies also are sluggish.

Growth Forecasts

The new fed funds rate compares with benchmark rates of 2 percent for the European Central Bank and 3.75 percent at the Bank of England. Japan’s average overnight bank-lending rate fell below zero for the first time earlier today.

Economists expect low rates and recent tax cuts to lift the economy to a 3.3 percent annual rate of growth in the third quarter and a 3.5 percent rate in the fourth, from 1.9 percent in the first three months of the year. Manufacturing, one of the hardest hit sectors of the 2001 recession, is showing signs of a rebound, according to two Fed bank surveys.

“All signs seem to be pointing to a stronger second-half,'’ said Tracy Mullin, president and chief executive officer of the National Retail Federation in Washington, which represents 1.4 million retailers. “This is just more icing on the cake.'’

Last Updated: June 25, 2003 16:33 EDT

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