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Fed Cuts Interest Rates

Federal Reserve policy-makers cut two key short-term interest rates again Tuesday, the third reduction in the past seven weeks.

The central bank's Federal Open Market Committee lowered the target for the federal funds rate - the rate banks charge each other for overnight loans - by 25 basis points to 4.75 percent from 5 percent. The Fed cut the discount rate, the cost of borrowing from the Fed, 25 basis points to 4.5 percent from 4.75 percent. One basis point is one one-hundredth of a percentage point.

In making the move, the rate-setting FOMC cited "unusual strains" on financial markets that could hinder growth going forward.

"Although conditions in financial markets have settled down materially since mid-October, unusual strains remain," the panel said in a statement accompanying its announcement at 2:19 p.m. EST.

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The market reaction was muted. The Dow Jones Industrial Average, which was down 75 points just before the news, was up as much as 36 points within 10 minutes. But the 30-year Treasury bond sold off a bit after the announcement. It was yielding 5.277 percent.

"That's the story," said Irwin Kellner, chief economist for CBS MarketWatch and the Weller professor of economics at Hofstra University. "You would have thunk that the market would be up, up and away."

"The market is not taking this as well as could be expected," Kellner said. "Maybe they fear that there's something else out there, another Long-Term Capital that the Fed knows about."

"Or maybe they're just reading this statement as saying, 'Hey, we cut rates three-quarters of a point, now leave us the hell alone,'" Kellner said.

Most Fed watchers expected the cut but said it was a close call because the U.S. economy remains healthy despite the global turmoil. Financial markets, which so concerned the Fed a month ago, also have stabilized.

But the Fed said that with three rate cuts, "financial conditions can reasonably be expected to be consistent with fostering sustained economic expansion while keeping inflationary presures subdued."

Indeed, U.S. stocks have rallied while the yield spreads between government bonds and corporate securities have narrowed.

But the arguments against lower rates did not sway the 11-member FOMC, which apparently felt the risks of further distress in financial markets outweighed the possibility that an excessive interest rate cut would fuel inflation.

"There's relatively little downside risk to cutting another 25 basis points," said Joel Naroff, chief bank economist at First Union.

John Ryding, chief economist at Bear Stearns, said holding steady on rates "could risk undoing much of the good work they've done in the past few months."

The Fed lowered the fed funds target rate on Sept. 29, and on Oct. 15 it reduced the fed funds and discount rates to prevent a liquidity crunch from seizing U.S. financial markets and driving the economy into a recession in sympathy with Asia.

As for the discount rate, it is governed by the Fed's board of governors, who act on the request of the 12 regional member banks. Only three of the banks this time called for the discount cut while eight of them asked for it in October.

Written By Rex Nutting

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