Fed seeks to calm markets after discount rate rise

Fed seeks to calm markets after discount rate rise
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First Published: Fri, Feb 19 2010. 12 34 PM IST
Updated: Fri, Feb 19 2010. 12 34 PM IST
Washington: US Federal Reserve officials moved to calm speculation that a surprise rise in its emergency lending rate could bring forward broader policy tightening, saying borrowing costs in the economy would stay low.
Fed chairman Ben Bernanke flagged the move last week, saying the US central bank aimed to widen the spread between its main policy rate that remains pegged near zero and the discount rate at which banks can borrow from the Fed.
However, no one in markets expected it to act so soon and the timing of the move well ahead of the 16 March policy meeting — prompted investors to price in a greater likelihood of a rise in the benchmark fed funds rate late this year.
The dollar jumped and government bonds and bank stocks fell after the Fed raised the discount rate by 25 basis points to 0.75% even as it cast it as a response to improved financial market conditions and not a change in monetary policy.
“This is a significant and likely symbolic move that will impact on market sentiment,” Robert Rennie, a strategist at Westpac in Sydney said in The Dealing Room, a Reuters Messaging chat room.
“The emergency easing cycle began with discount rate cuts - it was all about easing liquidity to banks. So the move to raise the discount rate means the long journey towards normalisation has begun.”
Thursday’s move is the first increase in any of the Fed’s lending rates since the financial crisis blew up in 2007 and the first rate change since December 2008.
“The modifications are not expected to lead to tighter financial conditions for households and businesses and do not signal any change in the outlook for the economy or for monetary policy,” the Fed said in a statement.
Overblown expectations
While investors initially brushed aside the Fed’s assurances that no tightening for the broad economy was on the cards, warnings from a senior Fed official that markets have gone too far in their tightening bets finally did sink in.
St. Louis Federal Reserve Bank president James Bullard said investors belief in high probability of a rise in the Fed’s benchmark rate this year was “overblown” and that the discount rate rise should not be seen as a policy signal.
“The discount rate move is part of a normalization process which is akin to our discontinuing many of our liquidity programs,” Bullard, who votes on the Fed’s interest rate-setting panel this year, told reporters in Memphis. “It does not indicate anything one way or the other about what we might eventually do with the federal funds rate,” he added.
The dollar pared gains and treasury futures trimmed losses, after Bullard’s comments and reminders from fellow Fed officials that cheap credit was still the order of the day.
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First Published: Fri, Feb 19 2010. 12 34 PM IST