Fed set for fresh rate cut

The US central bank, the Federal Reserve, will announce within the hour whether it has decided to cut interest rates further to boost the flagging American economy.

The Fed has already cut interest rates five times this year, but with corporate profits falling and growing talk of a US recession, it is likely to do so again.

The decision will be announced at 1915 London time (1815 GMT).

Economists are increasingly worried that the US economy has failed to respond to rate cuts so far.

Anecdotal evidence from companies still raises the question whether this economy has hit bottom or not

Lyn Reaser
Bank of America

"Anecdotal evidence from companies still raises the question whether this economy has hit bottom or not," said economist Lynn Reaser of Bank of America.

The National Bureau of Economic Research (NBER) - a private research organisation - has said the US could already be in recession, pointing to factors such as rising unemployment and slumping industrial production.

Most economists are expecting a further rate cut, but opinion is divided on whether it will be a half-point or quarter-point reduction.

With only this mild uncertainty ahead of the Fed meeting, markets around the world remained fairly quiet.

European stock markets were flat on Wednesday, although London closed up, with some gloomy corporate news tempering Fed-related optimism.

No impact

Since January the Fed has cut interest rates five times, each by half a percentage point, to 4%.

That is the highest number of consecutive cuts that Fed Chairman Alan Greenspan has made in his 14-year tenure.

However, despite the drastic easing of monetary policy, some economists are beginning to worry that the cuts are not having a big enough impact.

At the end of last week, this prompted an increasing chorus of Fed watchers to talk up the probability of a half-point cut.

The dilemma for the Fed is that while the US corporate sector shows few signs of revival, consumer confidence is recovering.

Calling for a smaller cut

That has prompted some to argue that the Fed would get a "bigger bang for its buck" in terms of stimulating growth if it opted for a smaller cut.

"The single best thing the Fed could do for both the financial markets and the economy would to be signal they are stopping," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson.

That way the Fed could bolster confidence by implicitly saying that the US economy was on track to recovery, they argue.

A quarter-point cut could also buy the Fed time while it assessed whether its previous moves had been effective.

Economic lag

The effects of interest-rate reductions usually take about six months to filter through into the economy.

Exporters have missed out on hopes of a weaker dollar

Nevertheless, Fed officials are said to be concerned that the US won't experience a rebound until early next year.

For a start, the US dollar has defied expectations by staying strong in the face of monetary easing.

Because of this, US exporters have missed out on hopes that a weaker dollar would make their products cheaper for foreign buyers.

Stubborn stock markets

Lower rates should also have boosted the stock markets, but again they have remained stubbornly low.

The Dow Jones Industrial Average, the index of leading shares on the New York Stock Exchange, is down 3% this year.

Meanwhile the Nasdaq index of high-tech stocks has fallen 16% this year, and is down 59% from its record high in the middle of last year.

In the last two weeks investors have been hit by a slew of corporate profit warnings, which culminated in downgraded forecasts from Merck, America's biggest pharmaceutical company, and the investment bank Merrill Lynch.

According to First Call, 140 companies in the broader Standard & Poor's market index - or 67% - issued negative pre-announcements for the June quarter.

No investment

The continued stream of profits warnings suggests that companies have still not been able to capitalise on the cuts by borrowing at lower rates to invest in new business.

The latest batch of economic data has also failed to convince economists that the US is out of the woods.

Earlier this month the Fed said that US factories, mines and utilities were operating at 77.4% capacity in May, the lowest rate since August 1983.

Similarly, in last week's reports the number of new claims for unemployment benefits were at their highest level since 1992, suggesting that there was still weakness in the job market.

Inflation fears

Other factors the Fed would consider are inflationary pressures.

So far the Fed has maintained that its monetary easing has not had an adverse effect on inflation because most companies have let the slowdown dent their profit margins, rather than opting to push prices up.

However, the prospect of yet another aggressive cut has made economists a little twitchy about the impact on long-term inflation.

But until Wednesday, the Fed will keep everyone guessing - and hoping that Mr Greenspan's latest prognosis on the ailing the US economy will be positive.