The Federal Reserve, the United States’s central bank, slashed interest rates in a dramatic move designed to prevent the ailing US economy falling into recession.
Abandoning its previous hard-line stance against inflation, the Fed cut by half a point both its federal funds rate — the nearest equivalent to the United Kingdom’s base rate — and the discount rate at which banks lend to each other.
Shares on Wall Street rallied instantly at the news that the Fed had performed a policy U-turn since stressing the risk of inflation at its last meeting little more than a month ago. The Dow Jones average put on 200 points within minutes of the announcement that the Fed funds rate would be reduced to 4,75% and the discount rate to 5,25%.
On the foreign exchange markets, by contrast, the dollar fell sharply to a new record low against the euro as dealers had less incentive to hold the US currency.
A statement explaining the Fed’s unanimous decision said the tightening of credit conditions on the world’s financial markets had the “potential to intensify the housing correction and to restrain economic growth more generally”.
It said it was “intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time”.
Wall Street had been expecting a cut of at least a quarter-point in the Fed funds rate, but the half-point reduction reflected growing fears at the central bank that the malaise in the US housing market could spread to the rest of the economy.
Fresh evidence has emerged of the weakness in the US real estate market with the news that sentiment among house builders fell for a seventh consecutive month in September as tougher mortgage requirements hindered sales.
The Fed hinted it might follow this week’s reduction with further cuts. “Developments in financial markets since the committee’s last regular meeting have increased the uncertainty surrounding the economic outlook,” it said. “The committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
Until recently the central bank had been concerned that the 17 quarter-point increases in interest rates since they hit a trough of 1% in 2003 might not have been enough to contain inflationary pressure.
The recent move marks a change of strategy, despite the risk that it will rekindle inflation and make it more difficult to attract foreign capital.
Martin Feldstein, president of the National Bureau of Economic Research, said: “I think that’s a good thing. It’s impressive that they were able to get unanimity on that. It was the right move. It can’t solve the problems that are weakening the economy [but] it can help offset them. At this point, it’s a toss-up [whether the US economy slips into recession]. What the Fed just did reduces the likelihood a bit.”
But Peter Schiff of Euro Pacific Capital said: “It is completely irresponsible of the Fed, but it’s par for the course. We have too much borrowing and consumer spending and the recession that is coming is necessary. This is not going to stop a recession, it’s not going to stop home prices from collapsing. It might slow down the process a few months but it’s just going to make it worse.” — Â