US Federal Reserve Rate Cut
The US Federal Reserve cut its interest rate by half a percent earlier this week, taking the rate down from 5.25% to 4.75%. This was more than the expected quarter percent cut, and brings pressure on the Bank of England to cut UK interest rates when it meets again in the first week of October.
The US move was seen to be a bold statement that it wants to avoid the US economy slipping into recession, and interest rates in the US are now a full point below the base rate in the UK. The “Fed” was concerned about the deepening financial crisis plunging the country into recession, and in all likelihood, taking much of the world economy with it, including the UK’s.
As the US consumers more goods than any other nation, if its growth were to slump then exporters to the US in other countries will be hit. The cut by the Fed was the first since 2003, and was accompanied by a bleak assessment of the economic future in the country. It said: “The tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets.”
The sub-prime crisis in the US has led to the country’s worst property slump for over 20 years, and it is affecting growth. The knock-on effects on sub-prime lending has led to turbulence in world markets. As sub-prime borrowers in the States – those poor families who took out loans when interest rates were as low as 1% - default on their mortgages, so the parcels of those loans have come to be worth nothing, and they have been passed on from bank to bank. No one knows, and most banks are not admitting, the extent of the exposure. The result has been that financial institutions are refusing to lend money to each other, and they are refusing to lend it to other companies, and those companies are now struggling to continue their normal business plans without ready cash.
The so-called credit crunch has led directly to Northern Rock being unable to fund its mortgages in recent days, as it borrows most of its money from the wholesale money markets, which have all but dried up.
The world has seen a strong period of economic growth, but if the US can’t stay on track then the impact will be global. Experts are suggesting that the Fed may well have to cut the rate again before the end of the year, because economic fundamentals are looking weak.
As the Fed made the bold move, it brought into stark contrast the attitude of the Bank of England which appears to have been slow to respond to the crisis. It has been criticised for its failure to act earlier to prevent problems at Northern Rock.
With inflation slipping back to 1.8%, and with householders still struggling with increasing mortgage rates, the Bank will be under enormous pressure to cut its rate in October. Stand by for a drop to 5.5%.
Published on September 26, 2007
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