U.S. Federal Reserve slashes key interest rate

The U.S. Federal Reserve slashed its key overnight lending rate by half a percentage point Tuesday in a dramatic move designed to prevent the U.S. from slipping into recession.

Stock markets, gold, loonie soar in response

The U.S. Federal Reserve slashed its key overnight lending rate by half apercentage point to4.75 per cent Tuesday in a bold attempt to prevent the turmoil in the U.S. housing and credit markets from spreading.

The deep cut surprised many market watchers, whohadpredicted a more modest move.

"We thought the odds were in favour of25 basis points rather than 50," said David Baskin, of Baskin Financial Services. "What concerns us is, the Fed sees the numbers before we do, and we wonder what they're looking at."

Analysts hadexpected the Fed to trim interest ratesin a bidto stop theU.S. housing recession from spilling over to the wider economy. The only question was how far the Fed would go.

Market expectations had been leaning towards a quarter-percentage-point cut. But some observers had suggested that only a half-percentage-point slash would provide the needed boost, given the depth of the problems.

In the end, the Fed sided with the "slash" crowd.

"The tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally," the U.S. central bank said in a statement.

"Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets."

It was the first cut in the benchmark federal funds rate in more than four years.

The Fed alsolowered the discount rate it charges for direct loans to banks by half a percentage point, to 5.25 per cent.

'A very aggressive move'

"It was a very aggressive move that really indicates that [the Fed is] a bit more concerned about … the economic issues facing the U.S.," TD Securities chief currency strategist Shaun Osborne told CBC News.

Some observers were not impressed, saying the Fed was rewarding those who'd made poor credit decisions.

"Like a teenager with a car and no curfew, we'll be havingmore problems down the road from these actions," said BMO's global foreign exchange strategist, Andrew Busch.

"But for now, who cares? Everyone's happy and it keeps the politicians at bay," he said.

The stock markets were certainly happy. The Dow Jones industrial average, which had been up 65 points just before the announcement, quickly soaredto a gainof more than 200 points and ended the day up 336 points at 13,739 —its biggest one-day point gain in five years.

The S&P/TSX composite index —which had been flat as the Fed released its news — added 195 points to close above the 14,000 level for the first time since July 31.

Gold futures surged to a 27-year high, above $735 US an ounce.

Loonie bolstered further

Tuesday's Fed rate cut highlighted the differenteconomic realities facingthe central banks of the U.S. and Canada.

The Bank of Canada left its key lendingrate unchangedduring its last policy announcement, on Sept. 5. The Canadian economy is faring much better than the U.S. economy these days — with more job creation, a healthier housing market, and robust domestic demand.

The next move for Canadian interest rates may well be an increase, not a decrease,as Bank of Canada governor David Dodge has pointed out that core inflation is above the bank's two per cent target and the economy is operating above its production potential.

That divergence in the two countries' interest rate policies is helping to drive the Canadian dollar towards parity with the American currency.

The loonie movedwell above 98 cents USTuesday as the U.S. dollar weakened dramatically following the Fed's announcement. It was quoted at 98.64 cents US at the close, up 1.36 cents on the day.