Fed Bumps Discount Rate!

In a surprise move, the Fed bumped the interest rate it charges banks for overnight loans up a quarter point on Thursday to 0.75%. After the markets closed at 4pm, the Fed made the announcement, avoiding a drop in the market. The move to raise the lending rate, called the “discount” rate, does not mean consumer interest rates will be going up as it doesn’t impact the federal funds rate. Jeannine Aversa write:

The central bank said the step should not be seen as a signal that it will soon boost interest rates for consumers and businesses. It repeated its pledge to keep such rates at record-low levels for an “extended period” to foster the economic recovery.

The Fed had signaled for weeks that a higher discount rate was coming, though the timing of Thursday’s decision caught some by surprise. It portrayed its action as moving its emergency program for banks closer to normal.

The Fed is basically telling banks they need to start figuring out how to survive without the lending safety net. While banks haven’t been leaning heavily on their ability to borrow from the Fed’s balance sheet as of late, they have benefited from the knowledge that the opportunity is there. But that security blanket will now be slowly pulled away. Time to take off the training wheels.

Bernanke did warn that this was going to happen in his speech last week. But few expected the cut to come this fast. What will be the impact? Perhaps not much in the short term, though intrabank lending rates may adjust upward given the start to the process of unwinding.

Over the next few months the Fed will make very calculated moves towards tightening the loose monetary policy that has dominated and stimulated the nation over the past two years. But the Fed fears tightening too fast and strangling the whole economy. Personally, I think leaving monetary policy loose for too long is letting the banks live off borrowed time and perpetuating a sluggish recovery process. It’ll be interesting to see if the Fed continues a policy of lightening fast policy changes as they did today.