The Dow Jones industrial average was up 40 points before the Fed's rate cut announcement. Investors were cautiously optimistic awaiting the Federal Reserve's policy announcement on interest rates.
The Federal Reserve announced a 0.25 percent reduction in interest rates. Most economists were anticipating a quarter percentage reduction in the key lending rate. However, many investors apparently had been hoping for a half-a-percent reduction in interest rates. These investors were disappointed after learning of the Fed's policy and stocks began a sell-of. The Dow plunged 250 points in afternoon trading as investors reacted to the news.
The NASDAQ and NewYork stock exchanges had both been steadily climbing for the past few weeks as investors became bullish in anticipation of rate cuts. Investors may have already priced in anticipated rate cuts into the price levels of stocks prior to today's sell-off.
After the Fed's announcement commercial banks quickly dropped their prime lending rate to 7.25 percent. This makes the prime lending rate at a two year low for both consumer and corporate lending. The Fed hopes to avert a recession by lowering interest rates to spur economic growth. Lower interest rates make it easier for businesses to borrow in order to spend on inventory and expansion. Consumers are able to borrow at lower rates to finance home purchases or spending.
The Federal Reserve in its statement left room for future rate cuts. The Fed announced that further rate cuts may be undertaken in the future if the credit crisis worsens or the chances of entering a recession increase.
Though a rate reduction is generally positive news for financial markets it is also a warning. The Fed's commitment to lowering interest rates signals that the economy may not be performing well and that there still exists a chance of the United States entering a period of recession.
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