WASHINGTON Wreckage from a massive crisis on Wall Street could prompt the Federal Reserve to do an about-face and once again cut a key interest rate today or possibly later this year, economists said Monday.
Just a few days ago, a rate cut appeared largely off the table. Now it has emerged as a possibility as the Fed prepares to meet today against a backdrop of historic upheaval in the U.S. financial system.
"It puts a Fed rate cut back on the table," said Stuart Hoffman, chief economist at PNC Financial Services Group.
Neither President Bush, nor Treasury Secretary Henry Paulson, who both offered words of reassurance Monday, could stem the panic. The Dow Jones industrial average plunged 504.48 points to close at 10,917.51. It was the Dow's biggest point drop since the September 2001 terror attacks.
On the other side of the Atlantic, major European central banks plowed billions into markets Monday with the hope of averting a lending freeze-up in the wake of the Lehman Brothers bankruptcy.
"It is an ongoing process, and we have to remain extraordinarily alert," said European Central Bank President Jean-Claude Trichet.
In Asia, China's central bank cut a key interest rate to stimulate growth as inflation has eased. It was the first rate cut there in almost six years. Chinese regulators have steadily raised interest rates over the past three years to contain inflation pressure.
During emergency sessions over the weekend, Fed Chairman Ben Bernanke and Paulson made clear there would be no government bailout of Lehman. The Fed took steps to keep cash flowing to major Wall Street players by expanding its loan programs, however.
Before those extraordinary events, the prevailing wisdom was that the Fed would hold its key interest rate steady at 2 percent today.
Although that still could happen, a growing number of economists and investors now believe there is a chance the Fed could reduce its rate by one-quarter or even a bolder one-half percentage point. Much hinges on the information the Fed gets about how the inner workings of the U.S. financial system are functioning and how Wall Street investors react to the crisis.
"It is a different ballgame. Anything can be expected and a rate cut is possible," said Richard Yamarone, economist at Argus Research. Yamarone thinks the Fed will decide to stay the course and leave rates alone, fearing another cut would hurt the value of the U.S. dollar more. Hoffman, too, isn't convinced a rate cut will happen.
Were the Fed to slice its key rate, the prime lending rate for millions of consumers and businesses now at 5 percent would drop by a corresponding amount. The prime rate applies to certain credit cards, home equity lines of credit and other loans. The Fed's key rate and the prime rate are at four-year lows.
Even if the Fed doesn't lower rates today, analysts believe the central bank could switch signals and suggest it could cut rates sooner down the road.
Over the last few months, Bernanke and his Fed colleagues have signaled that the central bank's next move on interest rates would probably be an increase to fend off inflation. Given all the economic and financial stresses, though, economists are now saying the likelihood of a rate increase over the next six to nine months is virtually nil.
A recent retreat in record-high oil prices and improved readings on wholesale prices, however, gives the Fed more leeway to lower rates if needed or at least hold them steady.
The Fed in June halted its most aggressive rate-cutting campaign to shore up the economy out of fears that those low rates were aggravating inflation. It didn't budge the rate at the last meeting in August for the same reason.
Fed officials have suggested that harder-to-get credit and financial troubles have blunted the energizing impact of the central bank's already-ordered rate cuts on consumers and businesses. Economic growth is slowing and the unemployment rate is at a five-year high of 6.1 percent.
Some argued that an additional rate cut might offer a psychological boost to shaken Wall Street investors, but probably wouldn't do much to turn around worried consumers and bolster the economy. Others feared another rate cut could send a wrong message to financial companies that made bad bets.
"I see very little gain of lower rates at this time and some may argue that extremely low rates may encourage the type of risky behavior on the part of investors which is exactly what the Fed wants to avoid," said Victor Li, an economics professor at the Villanova School of Business.