FED slashes rates to head off slowdown

Stocks surged after the US Federal Reserve moved aggressively to head off the risk of asharp slowdown in the US economy yesterday by cutting interest rates 50 basis points to 4.75 per cent.

The Fed said the rate cut was to "help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets". It was also intended to "promote moderate growth over time".

It also cut the discount rate at which the US central bank lends directly to banks by 50bp and held out the possibility of further interest rate cuts to come.

Tightening in credit conditions had the potential to "intensify the housing correction and to restrain economic growth more generally", the Fed said.

Hinting at possible further easing, the Fed said market dev-elopments had "increased the uncertainty surrounding the economic outlook".

It would "continue to assess the effects of these and other developments" and "act as needed" to pursue its dual objectives of stable prices and sustainable economic growth.

The S&P 500 index was up2.14 per cent at 1,508.29, after having been higher by about0.5 per cent in early afternoon trade. The financial sector led the gains.

The dollar set a new record low of $1.3964 against the euro, while interest rate futures continued to price in more rate cuts over the next 12 months, with the three-month rate, seen at 4.28 per cent by September 2008, down from 4.45 per cent early in the day.

Bond yields diverged as the yield on the policy-sensitive two-year note plunged 11bp to3.95 per cent, while the yield on the 30-year bond rose sharply.

The long bond yield rose to4.8 per cent from 4.74 per cent. Gold prices rose to a 26-year high of $733.40 an ounce. Oil also hit a record high in the US.

Core inflation, the Fed observed, had "improved modestly this year" - a significant shift since the previous meeting, when it believed a sustained decline in inflation had not yet been "convincingly demonstrated". But "some inflation risks remain" and the committee pledged to "continue tomonitor inflation developments carefully".

This reference is a reminder that, while no policymakers formally dissented from yesterday's decision, a number of officials remain worried about inflation.

Opting for an aggressive 50bp cut rather than an incremental 25bp reduction reflects the Fed's reluctance to fall behind at a time when the economic outlook is evolving rapidly.

Officials are anxious to act pre-emptively to reduce the risk of a severe slowdown that could turn into a recession, even though there is little evidence to date that the economy is approaching such a tipping point.

To the extent that they are able to reduce the recession risk, their actions should helpstabilise financial markets, in particular the market formortgage-backed securities.

Some of the most senior officials favoured a 50bp move to create a positive psychological effect on the markets.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

UK holds interest rates at 5.25%

The cost of borrowing remained at 5.25 per cent on Thursday but a large majority of economists expect the Bank of England to deliver another increase in May.

The Bank’s decision not to change its main interest rate followed evidence that industrial growth is slowing and the housing market may be losing some of its vigour – and it suggests the Bank is prepared to wait and see whether the three previous increases since August have cooled demand.

Analysts had been divided about the chances for a tightening of monetary policy this week.

The Bank’s own forecasts have suggested another quarter-point increase is necessary to push inflation back down to its 2 per cent target from a current annual rate of 2.8 per cent.

The absence of a move in April makes it increasingly likely that the mooted increase will be delivered in May, when the Bank publishes it next quarterly inflation report.

The view that the Bank’s monetary policy committee would stay its hand this month had gained ground on Thursday morning after the Office for National Statistics said UK manufacturing output contracted unexpectedly in February.

The 0.6 per cent fall in output between January and February was the second month in a row the sector had shrunk and marked the biggest decline since October 2005.

After adding the mining and utility sectors, industrial production as a whole fell by 0.2 per cent month-on-month, a much weaker performance than analysts had forecast.

The underlying trend was also weak. In the three months to February, manufacturing fell by 0.2 per cent, a decline matched by overall industrial production over the same period.

However, the MPC will also have had to consider data, published since its last meeting, that has shown inflation nudging back up, strong business investment, rebounding financial markets and firms exhibiting more pricing power.

Countering those factors is the apparent lack of any serious wage inflation and a slowing housing market.

The Halifax said on Thursday that house prices rose by 1 per cent in March but that the the first three months of the year saw prices climb by 2.8 per cent compared to 4.2 per cent in the fourth quarter of 2006.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

Growing speculation of UK rate hikes

The tension mounts ahead of the Bank of England rate announcement on Thursday. Sterling has been benefiting from increasing data backed speculation that there will be another rise of 25bp taking base rates in the UK to 5.50%.

Yesterday the UK published figures showing homeowners profiting from soaring house prices to fund consumer spending alongside buoyant conditions in the manufacturing sector.

Equity withdrawal in the quarter rose dramatically to £14.6bn from £12.2bn in the previous three months. Also adding fuel to the fire is the upbeat manufacturing data of late.

The latest purchasing managers' survey of manufacturing showed that over the first quarter as a whole the UK is still experiencing the fastest expansion in British industry for nearly three years, with new orders at their strongest since the end of 1999.

The US also had PMI data out yesterday. US factory activity grew in March but at a slower rate than in February with a jump in prices paid but contraction in employment.

The data suggests moderate manufacturing sector growth while price pressures fuelled by higher energy prices continues unabated. The prices data will provide another indication that the Fed cannot be complacent on the inflation side even with soft growth.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

Bernanke plays down need for rate cuts

Ben Bernanke challenged market expectations of early US interest rate cuts on Wednesday, saying he remained comfortable with rates on hold in spite of recent adverse economic data.

However, the Federal Reserve chairman said the risks to both inflation and growth had increased in the past few weeks and the US central bank would be flexible in responding to future economic news.

Mr Bernanke told the joint economic committee of Congress: “To date the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing in core inflation.”

The Fed’s recent policy statement – which baffled markets when it was released a week ago – was not intended to signal that the Fed now had a neutral policy stance, he said.

“I want to emphasise that we have not shifted away from an inflation bias,” he said.

Mr Bernanke said changes to the Fed statement were intended to give it greater scope to respond quickly if the outlook for either growth or inflation deteriorated significantly. “We are looking for a bit more flexibility given the uncertainty we face.”

Mr Bernanke also brushed aside comments by Alan Greenspan, his predecessor, that the expansion looked to be ageing, raising the possibility of a recession. Expansions did not “die of old age”, he said.

Mr Bernanke played down the threat from the subprime mortgage market and highlighted a new risk to growth from weak business investment. His comments came as the Department of Commerce released figures showing that durable goods orders bounced back weakly in February after a plunge in January.

“The possibility that the recent weakness in business spending will persist is an additional downside risk,” he said.

The Fed chairman hinted that the weakness had been a surprise: “The magnitude of the slowdown has been somewhat greater than would be expected given the normal evolution of the business cycle.”

But he added: “Despite the recent weak readings, we expect business investment in equipment and software to grow at a moderate pace this year.”

He was less alarmed than many investors by the distress in the subprime mortgage market.

“At this juncture...the impact on the broader economy and financial markets of the problems in the subprime market seem likely to be contained,” he said.

He recognised the risk that the housing market correction “could turn out to be more severe than we currently expect, perhaps exacerbated by problems in the subprime sector”. Overall, he indicated that the US central bank remained relatively upbeat about prospects for growth.

He said consumer spending “has continued to be well maintained so far this year” and said consumption “should continue to support the economic expansion in the coming quarters”.

Mr Bernanke added “the economy appears likely to continue to expand at a moderate pace over the coming quarters”.

He reiterated a series of reasons for the Fed to remain concerned about inflation. “The high level of resource utilisation remains an important upside risk to continued progress on reducing inflation,” Mr Bernanke said.

The contents of this blog are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The Wise Money Blog cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.