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Fed slashes interest rates

Wednesday, January 23, 2008
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The US Fed slashes interest rates by 0.75%

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An economy that is in crisis because of a series of shocks….. So a dramatic move in interest rates to act as a shock absorber?

A panic over-reaction or the right medicine to ward off the risk of a global big chill? The US Fed Reserve has cut interest rates by 0.75% - the biggest cut in US interest rates for a quarter of a century. Is this the sign that the wheels are coming off the US economy? Cutting interest rates by such a margin hints strongly that the US authorities are seriously worried about the likely scale and speed of an economic downturn. The volatility in the US stock market led the Fed Reserve to cut interest rates ahead of a scheduled meeting and before the market opened this morning. The likelihood is that they will cut rates again in the near future, perhaps at their next meeting. But what if the rate cuts don’t work? What if the fall out from the sub prime crisis, rocketing petrol and fuel bills does little to restore confidence and spending by American consumers? Aggressive interest rate reductions don’t necessarily have the impact on people’s spending that the textbooks might expect and if things get badly worse, the Fed Reserve will not have much left in the locker. And although the cost of borrowing money might now be falling, that does not mean that credit will be so easily available. Many of the lenders will now tighten their borrowing criteria.

There is little doubt that the US economy is weakening quite rapidly mainly due to falling house prices and a sharp decline in new housebuilding. There is a once in a decade mood change and a fundamental change in economic momentum. The Fed probably feared a major equity market crash which might have accentuated the decline in wealth and confidence. This contagion of the US debt crisis can spread quickly to stock and bond markets in other countries as well as send the real economy in the USA into a full-blown recession.

This rate cut won’t stop a recession because the economic forces bringing about a turning point in the US economy are very powerful. The move is perhaps better late than never, but the fall in interest rates might be because the US authorities are expecting some pretty dreadful economic data in the next few weeks – far worse than any of us including the financial markets are expecting.

Time to put your seat-belts on because this is going to get rough

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