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Dramatic 75 basis point cut in US rates

As markets reel, US central bank says it stands ready to act again; its next scheduled meeting is in a week’s time


IN A stunning response to the panic that triggered two days of frightening sell-offs on world stock markets, the US central bank yesterday slashed interest rates by a dramatic 75 basis points.

The historic move, made shortly before the opening bell of the New York stock market, is the biggest single cut since the US Federal Reserve used the short-term rate as a principal monetary policy instrument around 1990. It is also the first time that the central bank has cut rates in an emergency session since 2001 after the attack on the New York World Trade Center towers.

The Fed’s accompanying statement to the cut in interest rates to 3.5 per cent was brief and to the point: ‘The (Federal Open Market Committee) took this action in view of a weakening of the economic outlook and increasing downside risks to growth. 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. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labour markets.’

Wall Street responded in equally dramatic but mixed fashion, as futures markets on the Dow Jones Industrial Average, which had been down more than 500 points an hour before the stock market opened here, quickly cut those losses to the equivalent of a 100-point opening decline.

Within fifteen minutes, however, all the major US stock market indexes were plunging again. When the bell sounded to begin trading on the New York Stock Exchange, the blue chip Dow Jones index registered a 350-point, or 3.5 per cent, plunge that was pared down to 293 points, or 2.5 per cent five minutes later. By 11am New York time when The Business Times went to print, losses were further narrowed to 136 points as the Dow stood at 11,963.39.

Speaking just moments before the opening bell, John Canavan, market analyst at Stone & McCarthy Research Associates, said that he believed that the immediate impact of the Fed’s big move is questionable.

‘Futures initially broke higher when the Fed’s announcement came out, but they quickly fell back… That’s the market telling us that no one believes there’s a quick fix solution to the dangers and turmoil facing the US economy at the moment,’ he said.

In its statement, the Fed made clear that it is not done with interest rate cuts. It stated: ‘Appreciable downside risks to growth remain. The Committee will 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.’

Traders were already wondering when the next Fed interest rate cut might occur. ‘The FOMC sent a clear message that it’s not done after this 75 basis point cut. The anticipation of aggressive action should serve as somewhat of a counterpoint to the fears of what a recession in the US will do to the world’s markets,’ said Ryan, Beck chief investment strategist Joe Battipaglia.

‘It’s going to take some time, but the economy and the market will come back,’ he added.

When that comeback might be is certain to keep investors awake at night for many weeks to come. ‘We live in interesting times for better and for worse, and this is definitely one of the worst,’ said Mr Canavan. ‘There is no quick fix here. I expect we’ll see building support in the second half of the year as the Fed continues to cut rates, probably down to three per cent or lower.’

But he added: ‘There are so many wildcards out there right now, it’s impossible to make any predictions.’ The biggest wildcard is how consumer spending will be impacted in the second half of the year by the housing market slump, he said. ‘And until we know how that works out, we’re going to be stuck in a cycle of fear and hope.’


Source: Business Times 23 Jan 08


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