Quick Take: Federal Reserve Rate

December 16, 2008

By Arun Barman, Research Economist

The Federal Reserve cut the target for the federal funds rate to a range of zero to 0.25 percent. This is down from the recent 1 percent target rate. This the lowest level on record for the key interest rate.
The Fed also reaffirmed its commitment to buy large quantities of agency debt and mortgage backed securities to help support the mortgage and housing markets.

Housing starts fell to a seasonally adjusted annual rate of 625,000 in November. This was down 18.9 percent from a rate of 771,000 in October and down 47 percent from the November 2007 rate of 1,179,000. This is a record low in housing starts, since the Commerce Department began tracking the level in 1959.
Single family housing starts fell to 441,000, which is 16.9 percent less than October's rate of 531,000.

The Consumer Price Index fell 1.7 percent in November. This decline was mainly due to a 17 percent fall in energy prices. The Index is up 1.1 percent since November 2007.
The "core" CPI (which excludes food and energy) was unchanged in November. Over the past 12 months, the "core" index is up 2 percent.

Many economists were predicting a 0.5 percent decrease, but this action by the Federal Reserve is a sign that the bank is aggressively trying to provide liquidity to the system. The decrease in the federal funds rate will not necessarily drive down mortgage rates as many other factors are at play. With the target rate approaching zero, the Fed is not running out of monetary policy tools. It can still continue to implement "quantitative easing" techniques like buying mortgage backed securities, which has been helping to drive down mortgage rates.
Inflation numbers were driven primarily by a fall in energy prices. However, energy prices impact many other sectors of the economy. Look for downward price pressures to remain in the coming months with lower energy costs and a weaker economy.
The fall in housing starts to historic lows is indicative of the poor economic climate. However, with housing inventories remaining at high levels in recent months, fewer housing starts should help remove some of the overhang. A reduction in inventory might be good for housing prices over the long haul.

NAR's monthly official forecast as of December 9 (57k PDF)
GDP Q4: -5.6%
GDP Q1: - 1.9%
Unemployment rate by mid-2009: 8.1%
Average 30-year fixed mortgage rate by mid-2009: 5.8% assuming no buy-down policy

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