/ 22 January 2008

Fed slashes US rates in bid to thwart recession

The United States Federal Reserve on Tuesday slashed a key interest rate by a hefty three-quarters of a percentage point, the biggest cut in more than 23 years, after a two-day global stocks rout sparked by fears of a US recession.

The move, a rare one made between the US central bank’s regularly scheduled meetings, took the federal funds rate governing overnight lending between banks down to 3,5%, its lowest level since September 2005. The Fed also lowered the discount rate it charges on direct loans to banks to 4%.

”The Fed is very, very, very worried,” said John Tierney, an analyst at Deutsche Bank in New York.

The Fed’s bold bid failed to instill confidence in shaken financial markets as US stocks, playing catch-up with sell-offs around the world, fell sharply at the open. The Dow Jones industrial average was down about 1,1% in late morning.

Prices for US government bonds slipped, while the dollar fell sharply against the euro.

”The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth,” the Fed said, referring to its policy-setting Federal Open Market Committee.

”While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households,” it said.

Some analysts viewed the Fed’s surprise move, which came just a week ahead of its next regularly scheduled meeting on January 29 to 30, as a timely and much-needed effort to shore-up deteriorating confidence in global markets. Others said it signalled a sense of desperation.

”Plainly the Fed realised that to try to stay ahead of the market they had to act immediately. That is the positive reading of the action,” said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut. ”The negative viewpoint is that it smacks of panic.”

Shortly after the Fed announced it was lowering US interest rates, the Bank of Canada cut its key overnight interest rate by a quarter percentage point to 4% and said further cuts were likely to be needed.

More rate cuts?

Even after the Fed’s move, interest-rate futures markets showed a 74% chance of another half-percentage point reduction in US rates next week. They also pointed to a federal funds rate of 2,25% by mid-year.

The Fed rarely lowers borrowing costs in between scheduled meetings, but stock markets around the globe had sold off heavily this week, posing another challenge to an economy already struggling under the weight of a deep housing slump and tight credit conditions.

”Appreciable downside risks to growth remain,” the Fed said, adding that it would ”continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.”

The central bank said incoming data ”indicates a deepening of the housing contraction as well as some softening in labour markets”.

The rate cut was the first in between regularly scheduled Fed meetings since September 17 2001, the first day US financial markets reopened after the September 11 attacks.

The last time the Fed took actions that reduced the federal funds rate by at least three-quarters of a point was in October 1984. However, it only began to set an explicit federal funds rate target as its primary lever to influence the economy around 1990.

Prior to that, it had used the discount rate to signal its policy stance. It had cut the discount rate by a full point in December 1991. – Reuters