Half-point cut takes US interest rates to lowest level since Eisenhower era

The US Federal Reserve slashed its key short-term interest rate again yesterday and signalled yet more cuts could be in the offing if the ailing US economy fails to improve.

The cut in the Federal Funds rate by half-a-percentage point to just 2 per cent brings that rate to its lowest since 1961.

The US central bank also dropped its more symbolic discount rate by a half-point to 1.5 per cent, a level not seen since the second Eisenhower administration in 1958. Major commercial banks are now expected to cut their prime rates by a similar amount to 5 per cent. Mortgage lending rates are also likely to go down. The widely expected move is the 10th reduction this year and the third in the two months since the terrorist attacks on 11 September, and almost certainly will be followed by the European Central Bank and the Bank of England this week.

In its statement, the Fed's policy making Open Market Committee said that "for the foreseeable future, the risks are weighted toward conditions that may generate weakness" ­ a clear hint that its chairman, Alan Greenspan, will seek further reductions if needed. The signs are, they will be. The question is not that the economy, which officially shrank 0.4 per cent in the third quarter, is weak, but when it will start to recover. As the economic shockwaves of 11 September multiply, many economists fear a steeper decline in the current final quarter.

In the past few days, the economic news has grown steadily more dismal, capped by a 0.5 per cent jump in the unemployment rate in October alone ­ the largest single-month increase in 21 years, signifying the loss of 600,000 jobs. Especially worrying is the weakness in the service sector, where the closely watched National Association of Purchasing Management index plunged 10 points last month, the steepest decline since it was introduced in 1997.

With their jobs ever more at risk, consumers are unlikely to be splashing out for the crucial Christmas season, and most economists expect no significant turnaround before the second quarter of 2002. This is despite one of the most aggressive and sustained interest rate cut campaigns ever mounted by the Fed, adding up to 4.5 percentage points off short-term rates since January.

All this is intensifying pressure on Congress to pass the $70bn-plus package to boost spending and cut taxes sought by President George Bush. But the measure is bogged down, with Republicans calling for capital gains tax cuts and the Democrats fighting for more assistance for lower wage-earners and the unemployed. Without action in the next fortnight, analysts warn, it will be too late to affect Christmas spending.

Ahead of the Fed announcement, stocks drifted quietly lower, as market indices suggested a quarter-point lowering was more likely. But in the last hour of trading the Dow surged, to end up 150 points, or 1.5 per cent, at 9,591.1.

Some economists however said the central bank may have overreacted. "I belong to the 'save-your-ammunition' school," said Alice Rivlin, a former Federal Reserve vice-chairman. "The Fed's done an admirable job, but it's time to leave yourself some room for manoeuvre." Many experts also believe that there is plenty of stimulus already in the economy.

Others disagree, predicting that the Fed funds target ­ the overnight rate at which banks lend to each other ­ could drop to 1 to 1.5 per cent early next year. "There's still quite a bit for them to work with," Kathleen Stephansen of CSFB said.