Federal Reserve slashes US interest rates by half a point

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The Independent Online

The Federal Reserve slashed US interest rates for the second time in eight days in an attempt to end the credit crisis and pull the US economy back from the brink of recession.

The US central bank cut its interest rate target by half a percentage point to 3 per cent, on top of the emergency three quarter-point cut it sprang last week, and it once again signalled the state of the financial markets was its top concern.

The credit crisis has exacerbated a housing market downturn and begun dragging down GDP, and the stock market had last week threatened to crash on fears of a recession.

Yesterday, the Fed's Open Markets Committee kept the door open to more rate cuts in the coming months. "Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labour markets," it said in a statement.

"Downside risks to growth remain. The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks."

One member of the committee dissented, Richard Fisher voting to keep rates unchanged. However, while the Fed said it would continue to monitor inflation, it saw price pressures easing this year.

In the run-up to the decision, some share traders had feared a smaller cut in rates or a more hawkish policy statement, but the Dow Jones Industrial Average rallied by more than 200 points as investors digested the announcement. The gains, however, were wiped out in late-afternoon on news that FGIC, a small bond insurer whose products guarantee billions of dollars of mortgage-related securities, had been downgraded by a credit ratings agency. The Dow closed down 37.47 points at 12,442.83.

The dollar fell markedly against a basket of currencies in anticipation that the 125 basis-point cuts of the past eight days may not be the end of the Fed's easing.

Ken Landon, currency strategist at JPMorgan Chase, said: "Let's face it, the Fed was behind the curve before and now is trying to get to where they think they should be. The dollar may see some downside in the short term, but I think the market will start to reward future growth. At some point, the market is going to wake up and realise this is good for the US economy."

The US economy grew last year at its slowest pace in five years, dragged down by the collapse of the hous-ing market in many parts of the country. According to a first calculation of GDP, published by the Commerce Department before the Fed's decision yesterday, the US economy grew at an annualised rate of 0.6 per cent in the final three months of 2007. That means that GDP growth for the full year was 2.2 per cent, down from 2.9 per cent in 2006 and the worst rate since 2002, when the US was emerging from its last, shallow, recession.

The fourth-quarter GDP reading was much worse than Wall Street economists had predicted – their average forecast was for a 1.2 per cent annualised rate – but many observers found comfort in the details. There was a bigger than expected reduction in business inventories. "While slower growth is no surprise, the composition of today's report – featuring a very large decline in inventories in the quarter past – might raise prospects for a gain in real GDP in the first quarter of 2008," said Steven Wieting, Citigroup's senior US economist.

A jobs survey yesterday also provided some reason for optimism. Meant to predict the official figures due out tomorrow, the ADP payroll survey suggested the US economy added 130,000 jobs this month. That would more than reverse the contraction seen in December, which spooked stock markets and gave the Fed cause for its rate cuts.