US Fed cuts interest rates to 2 per cent as economy grows faster than forecast

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The Independent Online

The Federal Reserve delivered another quarter-point cut in US interest rates yesterday and hinted that its dramatic period of monetary easing may be coming to a close.

The decision came within hours of data showing that the US economy continued to grow in the first three months of the year, defying predictions that it has entered a recession, but the Fed's open market committee, the FOMC, said that the credit crisis continued to be a drag.

Cutting its main federal funds rate target to 2 per cent, the FOMC said: "Economic activity remains weak. Household and business spending has been subdued and labour markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth."

Two FOMC members dissented, arguing that rates should be held steady to prevent inflation from racing higher. Financial markets had anticipated a cut, however.

Investors immediately began the close textual analysis always required by an FOMC statement. The initial reaction was that the statement was not as hawkish on inflation as anticipated, repeating that the Fed expected prices, even of fuel and food, to moderate as the year progresses.

The market had also expected a clearer hint that the Fed would now pause its series of interest rate cuts, which have brought the federal funds rate target down from 5.25 per cent when the credit crisis erupted. The FOMC did, however, note the "substantial easing" of monetary policy that it has already delivered, and dropped a line from the previous statement that noted "downside risks" to the economy.

The Fed has eight weeks until its next meeting, during which time tax rebates will be mailed to millions in a $150bn (£75.5bn) government attempt to encourage spending and boost the economy.

Many economists said the Fed had effectively moved to a neutral bias on the future direction of rates, but not everyone agreed. Steven Butler, head of foreign exchange trading at Scotiabank in Toronto, said: "I think it leaves the door open for more cuts. It's way too soon to say they are done."

There were also mixed reactions to yesterday morning's GDP figures, the first estimate of economic growth in the quarter ended 31 March. That came in at 0.6 per cent, sluggish but ahead of Wall Street's expectations. A 5.5 per cent growth in exports, largely fuelled by the weak dollar, helped to offset big drops in housing-related growth and in manufacturing and a new slowdown in the commercialconstruction industry. GDP growth would have been negative had it not been for a build-up in inventories, an extra $1.8bn of stockpiled goods that is yet to feed through the economy.

Kevin Logan, senior US economist at Dresdner Kleinwort in New York, said: "I think that this was probably involuntary. Manufacturers have been scaling back production now that demand is slowing as much as it is. What that suggests is that we will see a draw-down of inventories in the current quarter that will act as a drag on GDP."