Fed May Boost Discount Rate Before Next Meeting, Economists Say

March 19, 2010

Bloomberg

Joshua Zumbrun and Craig Torres

The Federal Reserve may increase the discount rate, charged on direct loans to banks, before the next meeting of the Federal Open Market Committee on April 28, economists said.

“It’s going to happen at some point,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. “Whether it’s today, whether it’s next week or next month is hard to say.”

U.S. stocks fluctuated as speculation the Fed will raise the discount rate tempered gains spurred by further evidence that the economy is strengthening without stoking inflation. The Standard & Poor’s 500 Index fell 0.1 percent to 1,165.52 at 3:59 p.m. in New York.

The speculation is circulating one month after the Fed announced the first increase in the discount rate in more than three years, widening the spread over the benchmark federal funds rate to 0.5 percentage point. Prior to the financial crisis, the Fed kept the primary credit discount rate 1 percentage point above the target for overnight lending between banks.

Federal Reserve spokesman David Skidmore declined to comment.

The central bank described the Feb. 18 move as a “normalization of the Federal Reserve’s lending facilities” and said it didn’t signal a change in the outlook for monetary policy or the economy. The S&P 500 rose 0.7 percent on that day.

Emergency Backstop

The Fed closed four emergency backstop lending programs in February and plans to finish a $1.25 trillion mortgage-backed securities purchase program this month. Discount-rate increases are necessary to help push banks back into the federal funds market for day-to-day funding needs, said Lou Crandall, chief economist at Wrightson ICAP LLC.

The Fed Board of Governors met to discuss the discount rate on March 15, a day before a meeting by the Federal Open Market Committee to discuss monetary policy, according to the Board’s Web site. The board meets on a regular basis to discuss whether to change the discount rate.

The board on March 16 held a “general discussion of discount window matters” with the FOMC, the Web site said. Such a discussion wouldn’t be unusual either at a time when lending programs, financial stability and bank reserves are all part of the FOMC’s discussion about its monetary policy stance.

“There has been no decline in borrowings since the discount-rate increase, which is why it is entirely possible they want to raise the discount rate in the days ahead,” Crandall said. “Their stated rationale for raising the rate was to turn it into what it used to be: a liquidity backstop instead of a primary source of funding.”

Level of Borrowing

Discount window borrowings stood at $14.1 billion Feb. 17, one day before the Fed raised the rate to 0.75 percent from 0.5 percent. Borrowings stood at $13.8 billion last week.

Feroli said there is no reason to believe the Fed would raise the rate today solely because the date is the same as the last increase.

“The Fed is not into numerology,” he said.

The Fed increased the term on discount-window loans to 90 days during market turmoil in March 2008, and reduced it to 28 days on Jan. 14 this year. The Fed announced in February that the term for loans would return to overnight.

The cost of borrowing overnight in dollars between banks in London has risen in recent weeks, according to the British Bankers’ Association. Overnight Libor rose to 22 basis points from 17 basis points a month ago. A basis point is 0.01 percentage point.

Requests From Boards

Discount-rate changes are requested by boards of directors at the 12 regional Fed banks and are subject to final review and determination by the Board of Governors in Washington. Fed governors review requests about every two weeks.

“Another increase in the discount rate could be coming soon,” Laurence Meyer, a former Fed governor who is now vice chairman of Macroeconomic Advisers LLC in Washington, said in a March 15 briefing.

“The case for doing it sooner rather than later is clear- cut,” Meyer said. “The sooner the next increase comes, the easier it will be to convince market participants that discount rate decisions at this point are all about liquidity policy and have nothing to do with monetary policy.”

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