Dow tumbles after 'inadequate' quarter-point rate cut from Fed

The Federal Reserve cut interest rates in the United States for the third time in as many months, but the stock market went into a dive yesterday as investors accused the central bank of complacency.

The quarter-point cut was less than many in the market said was needed to forestall a recession and to head off the worst effects of the continuing crisis in the credit markets.

The Fed, led by its chairman, Ben Bernanke, is wrestling with how to restore life to the credit markets, to consumer confidence and to the ailing US housing market without reigniting inflation in some corners of the economy.

Unlike after its last meeting at the end of October, the Fed did not say that the risks to the economy were equally balanced between inflation and slower growth, but it did labour concerns about the high prices of fuel and commodities.

One member of the Fed's Open Markets Committee, Eric Rosengren of the Boston Fed, dissented from the quarter-point decision, saying that a 50-basis-point cut would have been better.

The cut takes the main Fed funds rate to 4.25 per cent, a full percentage point below its level when the reductions began in September in response to the credit crisis. Financial markets expect further cuts in the new year.

John Lonski, the chief economist at Moody's Investors Service in New York, said it was clear there was a disagreement between the Fed and the financial markets about the seriousness of the risks to economic growth.

"By cutting only 25 basis points, the Fed effectively conveys its sense that recession risks are not as great as market participants believe," he said.

"The shallowness of the rate cut is somewhat surprising, given that the economic outlook has worsened since 31 October. All of this is to suggest that the Fed is fairly confident that what lays ahead for the US economy is nothing worse than a rough patch."

In a second disappointment to the market, the Fed also cut the so-called "discount rate" at which it lends money into the banking system by just 25 basis points. A more aggressive cut had been predicted as a way to encourage banks to use the Fed as a lender of last resort and kick-start inter-bank lending.

Banks are less keen to lend to each other while the scale of losses on sub-prime mortgages remains unclear, and activity in the credit markets has slowed to a crawl as a result. This in turn is causing funding problems for all sorts of businesses that rely on the credit markets for short-term finance and could tip the economy into a hard landing.

The Dow Jones Industrial Average plunged 294.26 to 13,432.77, and investors fled to the relative safety of government bonds.

Ken Landon, a foreign exchange strategist at JP Morgan Chase, said that the more hawkish than expected approach from the Fed was bearish for equities, but would help to strengthen the dollar.

Where previously the Fed had said that its policy actions were meant to "forestall" a slowdown in growth, yesterday it acknowledged harder times were already upon the US economy.

"Incoming information suggests that economic growth is slowing," the Fed said, "reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today's action, combined with the policy actions taken earlier, should help promote moderate growth over time."