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Fed cuts US interest rates by half a point

Open Markets Committee cites heightened geopolitical risks for continued weakness in spending

Philip Thornton,Economics Correspondent
Thursday 07 November 2002 01:00 GMT
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The US central bank yesterday responded to mounting fears of a world recession in dramatic style by cutting interest rates by half a point.

The Federal Reserve cut its base rate to a fresh four-decade low of 1.25 per cent but ruled out the prospect of more assistance before next year at the earliest.

The cut was larger than the quarter point that the markets had bet on and share prices on Wall Street rose in celebration, with both the blue-chip Dow Jones and the hi-tech dominated Nasdaq indices ending up more than 1 per cent.

The decision ­ which was a unanimous vote ­ was the first change in interest rates in almost a year and the 12th straight rate cut since the beginning of 2001. Only one in seven US economists had predicted the move. On seeing the news one analyst said simply: "Wow."

But the Fed signalled that it planned to keep rates on hold for the foreseeable future, saying the risks to the economy were balanced between weakness and inflation.

It said that a combination of growing uncertainty over the economy combined with "heightened geopolitical risks" ­ code for war with Iraq ­ had put the brakes on spending, production and employment. Meanwhile inflationary pressures were "well contained".

"In these circumstances, the committee believes that today's additional monetary easing should prove helpful as the economy works its way through this current soft spot," it said.

"With this action, the committee believes that, against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are balanced with respect to the prospects for both goals in the foreseeable future."

Analysts said the Fed had felt the need to kick start the economy but added that it had, in effect, ruled out another rate cut this year. Alan Ruskin, the research director of 4cast in New York, said: "The Fed could [cut] again if the soft spot proves more than temporary, but the message we read is one of reluctance to ease again."

The decision came as the National Bureau of Economic Research, which dates US recessions, said "recent data" had forced it to delay its decision on whether the downturn that began in March 2001 had come to an end.

At the Fed's last meeting on 24 September, policymakers opted to keep rates steady, saying that monetary policy would foster economic growth. But two members broke ranks and called for an immediate cut.

Since then the Fed has performed a rapid U-turn. Just three weeks ago Fed officials were describing interest rate policy as "accommodative".

But in mid-October three well-sourced reports that the Fed would cut by the end of the year sparked concern that the Fed was growing gloomy about economic prospects.

Since then manufacturing has contracted, household income and spending have fallen and the jobless total has risen. The focus now shifts across the Atlantic with the Bank of England and European Central Bank both setting monetary policy at lunchtime today.

The Bank of England's decision is still in the balance despite the cut ordered by the Fed and its gloomy statement.

Instead, the announcement by the US central bank appeared to have hardened the divergent opinions that economists have taken ahead of the UK decision.

Michael Saunders, European economist at Citigroup, said a cut by the Fed actually reduced the need for the UK to take action as the UK's economic problems were linked with weak global demand.

Alan Castle, the UK economist at Lehman Brothers, had given a 50-50 chance of a rate cut before last night's decision. He said: "I don't think it changes anything. The Bank's decision will rest on the committee's view of the medium-term prospects."

Philip Shaw, the chief economist at Investec, said yesterday's vote added to the reasons for a UK cut. "If the Fed is harbouring sufficient concerns to cut by a half-point the MPC will be viewing the outlook for the global economy with a similar degree of worry."

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