US rate hopes rise as economy weakens

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The key policymaking committee of the US Federal Reserve meets tomorrow with hopes riding high that it will cut interest rates by a further quarter point to 5.25 per cent.

Mark Cliffe, international economist at HBSC Markets said the odds favour such a cut: "They showed in December that they were ready to cut rates despite the ongoing wrangling over the budget, and the evidence since then is that the economy continues to weaken."

With yields on three month Treasuries at just over 5.10 per cent last Friday, the market is pricing in a further reduction in the Federal funds rate at which banks lend to each other overnight. Yields three years out are well below 5.25 per cent.

The extent to which the market expects a further cut can be gauged from the drop in yields on most US Treasuries since the Fed reduced the target fed funds rate last December. This has been particularly marked at the short end of the yield curve.

The markets' confidence that US Fed will cut rates again comes from accumulating evidence that the economy is weakening and that inflation remains under control.

Employment growth was slightly stronger than anticipated, with non-farm payrolls rising in December. However, hours worked fell and the January Employment Report is expected to see growth of only 125,000 jobs . The unemployment rate is forecast to rise from 5.6 to 5.7 per cent.

A particular area of weaknessis manufacturing. The inventory overhang is putting manufacturers under intense pressure to satisfy demand from stocks.

Meanwhile the Fed's recent Beige Book was notable for the absence of inflationary pressures. Consumer price inflationrose 2.6 per cent in November.