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Wednesday, November 18, 1998 Published at 06:40 GMT


Business: The Economy

Third cut in US interest rates

The guardian of inflation has eased recently

The US central bank, the Federal Reserve has cut rates for the third time in as many months.

It lowered US Federal Funds rate by 0.25% to 4.75%.


Richard Quest: "A strong stimulus to the economy"
It also cut the more symbolic discount rate (the rate at which it would lend to banks in an emergency) by the same amount.

The aggressive move raised hopes that interest rates around the world will be heading downwards.

The Fed first started cutting rates at its last regularly scheduled meeting in September.

It then surprised the financial markets by making another emergency rate cut of 0.25% in between meetings.


[ image: Alan Greenspan has been worried about the global economy]
Alan Greenspan has been worried about the global economy
The Fed acted again to reassure financial markets amid continuing concern about the effects of the financial crisis on the performance of the US economy.

"They're still concerned about that this credit crunch could still bring the economy down - that's why they are easing," commented Elliot Platt of stockbrokers Donaldson Lufkin and Jenrette.

The Dow Jones Industrial Average of leading shares immediately rallied, moving back into positive territory and above the historic 9000 level, near its highs over the summer.

US economy still strong

The Fed acted despite the fact that the US economy is still growing fast.

Inflation does not seem to be a threat, with consumer prices rising this past month by only 0.2%.

The manufacturing sector is suffering from lack of demand in Asia, but consumer spending continues to be strong and unemployment is low.

However, the biggest worry is the international economic environment.

With a third of the world's economy in recession, the US central bank does not want to take any action that would push Latin America or Eastern Europe over the edge.

Earlier today, in its gloomy forecast for the world economy, the Organisation for Economic Cooperation and Development warned that US rates would have to come down by another 0.5% just to ensure to that its economy continued to grow by 1.5% next year.

The Fed said that its actions since September aimed "to be consistent with fostering sustained economic expansion while keeping inflationary pressures subdued."

Market recovery

The US stock markets have recovered sharply since their low in August.

On Monday the Dow Jones Industrial Average, the leading indicator of shares on the New York stock market, touched 9000, not far from its all-time high of 9337, and up 18% from its low on 31 August of 7539.

The improvement has boosted consumer confidence, but the Fed has worried in the past that the "irrational exuberance" of the stock market was unsustainable.

Now it appears that the US central bank is worried about conditions in credit markets, where large companies borrow money in the form of bonds to finance investment.

The interest rates charged to these companies have remained very high despite the cut in base rates.

In explaining its latest move, the bank said that "although conditions in financial markets have settled down materially since mid-October, unusual strains remain."

World rate cuts

Since the Fed cut rates, it triggered a wave of cuts across the world.

The UK has since cut interest rates by 0.75%, Canada by 0.5%, and Thailand by 1%.

In preparation for the creation of the single European currency, Ireland has cut rates by 2.5%, and Spain and Portugal have cut by 0.75%.

The Fed will want to maintain the momentum of interest rate cuts to ensure that world growth recovers next year.

The International Monetary Fund has predicted a pick-up in the second half of next year, but that depends on the continuing decline in world interest rates.

In the UK, Chancellor Gordon Brown's hopes that he can maintain his spending plans by meeting his economic target of 1-1.5% growth next year, also depend on UK interest rates continuing to fall sharply.

So the Fed's decision has repercussions far beyond US shores.



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