Fed cuts rates by half point
U.S. leads wave of global interest rate cuts
By Daniel P. Ray | Published: October 8, 2008
The Federal Reserve Board, in an emergency action coordinated with other central bankers around the globe, cut interest rates for some consumer loans by a half point early Wednesday in another step aimed at boosting an economy that has "slowed markedly in recent months."
|Fed funds rate vs. credit card rates|
When the Federal Reserve changes the fed funds rate, it also changes the prime rate, which many credit cards are pegged to. However, because card issuers can change rates at any time for any reason, card rates do not always fall when the Fed cuts rates. In addition, some cards have hit rate "floors" and will fall no further.
Sources: Federal Reserve, CreditCards.com rates surveys
Today's rate cut was extraordinary. It was made in conjunction with similar actions by the Bank of Canada, the Bank of England, the European Central Bank, Sverges Riksban and the Swiss National Bank. All cut their interest rates in an effort to prevent a teetering financial system from falling into collapse.
"The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures," the Fed said in an early morning statement announcing the rate cut. "Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation."
What it means to consumers
For consumers, the rate cut's effect will be muted. Here are some of the ways it will -- or won't -- be passed along.
Variable rate credit cards in the United States are usually pegged to the prime rate, so a decrease in the prime will usually mean lower interest rates for holders of those cards. However, these are unusual times. The Fed has already lowered rates substantially in the past year, and many credit card have "floor" rates beyond which the issuer won't cut them. With the fed funds rate so close to zero, many cards had already hit their floors.
In addition, many issuers will not pass along the rate cut because the cardholders are on "fixed rate" cards, not pegged to the prime. In times of falling rates, card issuers tend to issue more fixed rate cards.
Finally, card issuers may change terms and conditions at any time, for any reason. Typically, variable cards' rates are set at prime, plus a margin based on the cardholder's credit history. For an average cardholder, that's around 5 to 7 percent. Say someone has a good credit history, and until yesterday had a card rate set at 10 percent -- a prime rate of 5 percent plus a margin of 5 percent. With the prime rate cut to 4.5 percent, the card issuer may simply decide to up its margin to 5.5 percent, and keep the rate cut for itself.
Home equity lines of credit:
Holders of this variable-rate product also have rates typically tied to the prime rate, so the monthly payments on existing balances should fall. However, in this credit crunch, banks have been revoking unused lines of credit, so a borrower is less likely to be able to take advantage of this rate cut with new borrowing.
Adjustable rate mortgages:
As with credit cards, the rate cut may or may not be effectively passed along, but for a different reason. Adjustable rate mortgages are tied to different indexes than the prime rate. Some are tied to the international rate, the LIBOR (London Interbank Offer Rate). The LIBOR has spiked in recent weeks, so owners of those mortgages have faced higher payments. The economic turmoil has had the opposite effect on those whose rates are tied to Treasurys. That index has fallen sharply. The Fed's move, if it's effective, will tend to bring those two indexes closer together.
The Fed meets again Oct. 28-29, and its rate-cut announcement hinted that this rate cut may not be its last. Inflationary pressures have eased, the statement said, and inflation-fighting through rate increases is one of the Fed's chief monetary policy weapons. With inflation less of a threat, "The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability."
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