US Fed cuts interest rates to 4.5%

Robust growth figures cheer Wall St; Dow Jones surges after further easing; Oil at new peak
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The Independent Online

The US Federal Reserve cut interest rates by a quarter percentage point to 4.5 per cent yesterday, as widely expected. Ben Bernanke, the Fed's chair, and his colleagues obviously decided to give the markets a treat rather than a trick. Wall Street welcomed the move by the Federal Open Markets Committee, although some analysts were disappointed that the Fed hadn't opted for a deeper reduction of 50 basis points.

Yesterday's surprisingly rob-ust figures on US economic growth – 3.9 per cent on an annualised basis in the third quarter – may have prevented the Fed from being more expansive. American stocks rose on the news – the Dow Jones industrial average closed 1 per cent higher at 13,930.01 – locking in a third straight month of gains for the Standard & Poor's 500 index. A surge in gold and oil prices lifted the shares of miners and energy companies, while the Nasdaq rose to its highest in nearly seven years. US crude futures surged $4.15 higher to settle at a record $94.53 a barrel.

The cut follows the bold half percentage-point reduction in September, implemented at the height of the credit squeeze. Policymakers have now lowered their target rate for overnight loans between banks by 0.75 percentage point in six weeks, the most aggressive easing since the US economy was emerging from its last recession in 2001.

In its statement, however, the Fed was keen to maintain a sense of balance between the need to reassure financial markets that the much-needed commodity, liquidity, would be kept in ready supply, and the need to restrain inflation in the domestic eco-nomy. The Fed said: "Today's action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in fin-ancial markets and promote moderate growth over time."

However, it added a clear hint that the market ought not to count on many more interest rate cuts, if any. "Recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully." After yesterday's move, The Fed's Open Markets Committee seems content to "wait and see". "The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth."

Chris Jarvis, senior analyst at Caprock Risk Management in New Hampshire, said: "As exp-ected, the FOMC cut 25 basis points, but more importantly it appears that they are levelling off their rate cut mode, moving more to a balanced view going forward in our opinion. Given this view, the markets could be disappointed by the hawkish tones in the statement, taking some of the punch out of the punch bowl. Overall, with commodities and equities near their highs and the initial shock of the credit crunch fading, the move to the sidelines for a timeout seems logical, especially after the bullish jobs data in October and the GDP report today."

Indeed, were it not for the news from the Fed, today's headlines might well have been dominated by the startlingly robust state of economic activity stateside. Courtesy of the weak dollar, US exporters appear to have been doing especially well, up about 16 per cent, while consumer spending has been holding up well. The US economy grew at its fastest rate in a year and a half in the summer, according to the Department of Commerce, with consumer spending up a resilient 3 per cent.

Even so, most economists are sticking to the view that the brakes on this growth will be applied fairly sharply, with growth in 2008 closer to 2 per cent. Adam Slater, economic adviser to the Ernst & Young ITEM Club said: "Wherever you look, the US economy is suffering from a unique combination of weak consumer confidence and falling house prices, exacerbated by credit problems and high oil prices."

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