US Federal Reserve cuts interest rates by half point

Click to follow
The Independent Online

The Federal Reserve slashed US interest rates to 1 per cent last night in the hope of pulling the economy out of its funk and restoring order to the battered credit markets.

The half-point cut came in response to the collapse in consumer confidence and a slide in retail spending, the Federal Open Market Committee said in its accompanying statement.

"The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures," it said. "Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for US exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."

Concerns about inflation, which once tied the committee's hands, have all but evaporated. It said yesterday that the falls in oil and food prices meant price stability was being restored. Yesterday's decision was agreed unanimously by committee members.

The Fed has pulled interest rates down from 5.25 per cent in September 2007 as the scale of the credit crisis has been gradually revealed. US financial markets had already priced in the latest half-point cut, and investors' attention has increasingly turned overseas, amid expectations of dramatically easing monetary policy around the world.

Kevin Logan, the senior US econ-omist at Dresdner Kleinwort in New York, said that while the Fed's rate cut was important, its effect on the credit markets may be less than the numerous other programmes put in place to restore confidence and get banks lending to each other again.

"It's important because people expect it, and not to do it would cause consternation in financial markets," Mr Logan said. "Beyond that, the situation is complicated because money market rates are no longer anchored to the Fed Funds rate in the way that we are accustomed to. People are more risk-averse and are unwilling to accept the risk of lending, predominantly banks lending to each other. That has thrown up money market rates, despite Fed cuts, and it is why the Fed has created all these other programmes."

US equity investors endured another day of wild trading, with the interest rate decision only one preoccupation. The Dow Jones industrial average had been on course for a 300-point gain until ten minutes before the close, when Jeff Immelt, the chief executive of General Electric, said the conglomerate was aiming for flat profits next year on revenues that could be down 10 or 15 per cent. Analysts were previously hoping that the economic bellwether would manage 2 per cent growth in revenues, despite the credit crisis. The Dow plunged, ending down 74 points at 8,991.

Since the start of the credit crisis, the US central bank has dramatically widened its interventions in the markets, taking in a broad array of collateral in order to channel cash to the banks. Just since the middle of September, when the bankruptcy of Lehman Brothers brought the financial system to the brink of collapse, it has launched three initiatives to restore order to the commercial paper market, where big companies find the short-term loans they need to meet payroll costs and pay supplier invoices. Yesterday, the Fed extended another of those programmes, via which it is extending dollar loans around the world in the form of swap lines with other central banks. It said it would make money available to the emerging markets of Brazil, Korea, Mexico and Singapore.

On Monday, the Fed began direct purchases of commercial paper, in a move that significantly eased the pressure on companies. The total issuance of commercial paper due to be repaid in more than 80 days was a record $67.1bn that day, and was $41.6bn on Tuesday, compared with a daily average of $6.7bn last week. And in another sign that the credit markets are thawing, the London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars, dropped 0.05 percentage point to 3.42 per cent yesterday, its 13th straight drop, according to the British Bankers' Association.

The Fed has been fighting to restore normal functioning to the credit markets because of the effect that a freeze in lending will have on the real economy, which has been turbo-charged in recent years by the availability of cheap credit. The US government releases GDP figures for the three months to 30 September this morning, and many economists believe they will show the economy contracted during the period. A recession is traditionally defined as two quarters of declining GDP, although the formal arbiter in the US is a body called the National Bureau of Economic Research, which weights other measures, such as unemployment. A clear majority of economists believe the US is already in recession.

However, orders for durable goods were stronger than expected in September. Figures yesterday showed orders for these big-ticket manufactured goods rose by 0.8 per cent, surprising economists who had forecast a decline. Orders had fallen by 5.5 per cent in August.

Comments