Wall Street looks for cut in fed funds rate

Wall Street is betting on a cut in US interest rates as early as tomorrow, when the key open market committee of the Federal Reserve meets. A cut of a quarter point is expected in the federal funds rate, bringing it down to 5.5 per cent.

Donald Straszheim, chief economist at Merrill Lynch, is predicting that this cut will be followed by two further reductions, taking the fed funds rate down to 5 per cent by spring next year. A cut of over a quarter point is currently priced into the market for three-month Treasuries.

Fears that the economy is weakening are thought likely to prompt the Fed to act. The most recent economic figures have pointed to a slowing economy and an absence of any inflationary threat.

Ten days ago, the employment report, a key barometer of the state of the economy, showed only modest growth in non-farm payrolls. The monthly increase over October and November of about 100,000 was under half the growth shown last year when the economy was expanding fast. A further sign of increasing slack in the economy was a fall in the average weekly hours worked - a good proxy for GDP growth.

There has also been a sharp decline in the sales of new homes, which had helped bolster the economy following the decline in mortgage rates over the summer. In October, they fell to their lowest level since May.

Industrial production has been flat since August, bringing the annual rate of increase down to under 2 per cent compared with over 6 per cent at the beginning of the year. Retail sales, too, have been subdued.

The inflationary background should present few problems to the US central bank. Although wholesale prices jumped unexpectedly in November, pressures further down the pipeline have eased sharply.