US rate cut hope lifts Dow amid housing woe

Yet more depressing economic news emerged from the US yesterday, with only a hint from the Federal Reserve about an interest rate cut dispelling the general gloom.

The Federal Reserve's Beige Book, an anecdotal region-by-region survey of the US economy, suggested that it continued to expand between October and mid-November, but at a slower pace. Seven of the 12 districts reported slower growth, while the rest noted modest expansion or mixed conditions. The districts generally reported "relatively soft retail spending", with retailers "cautious" about Christmas. Demand for real estate remains "quite depressed, with only a few tentative and scattered signs of stabilisation amidst the ongoing slowdown". Tight credit conditions continue to "create barriers for some buyers", the Fed reported.

The anecdotal evidence matched the hard stats also released yesterday. Sales of American homes dropped to a record low in October, with prices tumbling more than 5 per cent; orders for goods such as refrigerators and televisions fell for a third consecutive month; and businesses are reportedly slashing investment.

Meanwhile, the chief economist at the International Monetary Fund has given a warning that the world economy could be facing what he called a "perfect storm". Simon Johnson said the combination of the credit crunch and high oil prices could bring a big reduction in international trade from which no one would be immune. He said projections for the American economy are too optimistic and the IMF expects to downgrade its growth forecast for the US and Europe.

Still, Wall Street was buoyed by remarks from the Fed vice-chairman Donald Kohn, who suggested it may be ready to boost the economy by lowering interest rates. Mr Kohn acknowledged uncertainty has become "unusually high" and "these uncertainties require flexible and pragmatic policymaking nimble is the adjective I used a few weeks ago". The Dow Jones Industrial Average rose 331 points 2.6 per cent to close at 13,289.5.

The Fed's Open Market Committee meets on 11 December to decide rates. It is providing $8bn (3.8bn) in additional assistance to US banks, just as the European Central bank is injecting a further €30bn (21bn) into sticky money markets. These tightened further yesterday, with the cost of borrowing euros in the wholesale market hitting six-year highs. London interbank offered rates (the benchmark lending rates between banks) for two-month euro contracts rose to 4.7 per cent, the highest since May 2001. The equivalent dollar and sterling rates are at one- and two-month highs respectively.

Banks are reportedly hoarding cash to repair balance sheets pummelled by credit-related losses. This is being exacerbated by liquidity concerns over the seasonally thin Christmas and new year period and a desire to present the best possible balance sheet numbers for year-end reporting purposes. Mr Kohn said that recent turbulence could further damage access to credit for households and businesses.

The US data was especially disappointing as the depressed state of the property market has greatly exacerbated problems for sub-prime borrowers, already under pressure as banks tighten lending criteria. Yet when US borrowers run into difficulties and their loans turn bad, that hits the banks' balance sheets again, adding a further twist to the credit squeeze and yet more defaults in an increasingly vicious circle.

The Mortgage Bankers Association said applications for mortgages fell last week and rates on some adjustable loans rose to their highest level in two months. Sales of existing homes in the States fell 1.2 per cent in October to an annual rate of 5 million weaker than economists had forecast and the lowest since the National Association of Realtors began tracking sales in 1999. Inventories of unsold homes rose 1.9 per cent to 4.45 million, equivalent to 11 months' supply. Prices fell 5.1 per cent, in line with recent figures from the benchmark Case-Shiller index which showed a decline in property values of 4.5 per cent for the third quarter of 2007 compared with the same period last year.

It all seems to have made US consumers and businesses more cautious. Orders for consumer durables fell 0.4 per cent in October compared with September, and bookings for non-defence capital goods (excluding aircraft), a proxy for future business investment, decreased 2.3 per cent.