Signs of recession in US vindicate Fed's rate decision

DIANE COYLE

Economics Correspondent

Clear signs that the US economy might be heading for recession - along with the lowest headline inflation rate for a decade - vindicated the Federal Reserve's decision on Wednesday to cut interest rates for the second time in two months. Analysts said further evidence of economic weakness would bring further reductions in interest rates.

France yesterday followed the wave of international interest rate cuts, reducing its main money market rate from 4.2 to 4.05 per cent. The Bundesbank stepped into the money markets to trim its repo rate to 3.3 per cent, down from 3.4 per cent earlier in the week.

The survey of American industry carried out by the National Association of Purchasing Managers showed that activity slowed worryingly in January. The index fell to 44.2 from 46 in December and stands well below 50, the dividing line between recession and growth.

Christopher Low, an economist at HSBC Markets in New York, said: ''This is the first of the big indicators to point in the direction of recession.''

He said there would definitely be further reductions in the cost of borrowing: ''The Fed has suddenly become a lot more receptive to signs of economic weakness.''

The NAPM predicted that employment in manufacturing would continue to fall for the forseeable future. The employment index fell sharply to 44.3 last month, pointing to the possibility that the crucial monthly employment report due out today would be weaker than expected.

Firms surveyed by the NAPM reported higher stock levels for the third month in a row.

Separate figures confirmed that inflation is not a concern in the US. Consumer prices increased by 0.2 per cent last month, a smaller-than-expected rise. The only significant price increase was in energy, due to the unusually cold weather. Oil prices have already fallen back from their mid-winter peak.

The rate of inflation fell from 2.6 per cent to 2.5 per cent in the 12 months to December, the lowest year-on-year rise since a 1.1 per cent increase1986 when oil prices collapsed. The core inflation rate - which excludes food and energy prices - was unchanged at 3.0 per cent in December.

David Bloom, an economist at James Capel, said: "The Federal Reserve has nothing to fear as far as inflation goes.'' He predicted the next few months would bring even lower inflation rates.

Some Wall Street economists were predicting yesterday that the Fed will cut its the Federal Funds rate again when it next meets on 26 March. It reduced the rate by a quarter of a point in July, December and again, to 5.25 per cent, on Wednesday.