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Last Updated: Thursday, 1 November 2007, 00:22 GMT
Fed delivers second US rate cut
Federal Reserve Chairman Ben Bernanke
The pressure is on Mr Bernanke to steer the economy out of trouble
The US Federal Reserve has voted to cut US interest rates from 4.75% to 4.5% to help revive the country's faltering housing and credit markets.

The move had been widely expected by traders, who have been relentlessly selling the dollar and buying higher yielding currencies in anticipation.

It came after surprise data showed that the US economy grew at its fastest rate in 18 months in the third quarter.

It follows last month's dramatic rate cut - the Fed's first in four years.

The move will make it cheaper to borrow money in the US and therefore lend support to consumers in the critical Christmas shopping period and continuing business investment, the backbone of national economic growth.

It also made dollar-denominated investments less tempting and drove the UK pound and euro even higher against the US dollar, as traders exchanged the greenback for sterling and the 13-member eurozone's currency for a higher rate of return.

They had the room to throw the market a 25 basis point bone while they're still trying to figure out how bad this housing pull-back will be
Scott Wren, senior equity strategist at AG Edwards & Sons

As it is thought that UK interest rates will stay unchanged at 5.75% when the Bank of England's rate-setting committee meets next week, the pound has become very attractive against the US dollar and reached a 26-year high against it on Wednesday - at $2.08.

Meanwhile, shares on Wall Street also climbed on the Fed's downward move, with the Dow Jones index of largest shares up 1% at 13,930, while the S&P 500 broader index also rose 1% at 1,549.4.

Inflation concerns

Analysts said gains were muted as a result of the Fed indicating that its decision did not necessarily signal a downward trend in interest rates, with the cut to 4.5% enough to deal with the economy's troubles unless new data is released that suggests otherwise.

The economy is facing a perfect storm right now of a crisis-related tightening of credit, higher oil prices and lower house prices
David Jones, chief economist, DMJ Advisors

In a statement after Wednesday's meeting, Fed policy makers said financial markets have "eased somewhat" since the summer mayhem and that now "the upside risks to inflation roughly balance the downside risks to growth".

This suggests that the need to keep inflation risks under control is still a priority for the Fed, particularly with oil prices bubbling to record highs almost daily and other commodities, such as wheat and sugar, also soaring.

One Fed policy maker, Kansas City's Thomas Hoenig, voted against the rate cut, supporting a move to leave rates unchanged at 4.75%.

The dissent, together with a more positive tone from Fed Chairman Ben Bernanke and his colleagues than in September, reassured investors that economic growth had not been derailed by the housing slump.

But there was an acknowledgement that the pace of economic expansion "will likely slow in the near term, partly reflecting the intensification of the housing correction".

No further cut?

Analysts were largely in consensus that the Fed made the right move to buffer the economy, and would now keep rates on hold at least until the end of the year notwithstanding further problems.

"They had the room to throw the market a 25 basis point bone while they're still trying to figure out how bad this housing pull-back will be and what its impact is on jobs," observed Scott Wren, senior equity strategist at AG Edwards & Sons.

Bob Walters, chief economist at Quicken Loans in Michigan, added: "The Fed is walking a tightrope and will take a wait-and-see attitude on future rate moves."

Many referred to the surprisingly good US data out earlier on Wednesday that showed the US economy had expanded by a faster-than-expected 3.9%, which would have contributed to the Fed taking a more hawkish stance.

But David Jones, chief economist at consultancy DMJ Advisors, was less sanguine.

"The economy is facing a perfect storm right now of a crisis-related tightening of credit, higher oil prices and lower house prices."

Continuing concerns

In September, policy makers at the Fed voted unanimously to cut US interest rates from 5.25% - a level where they had sat since mid-2006 - to 4.75%.

The bold intervention was designed to restore confidence in the housing market, which has badly suffered from the repercussions of 17 interest rate rises between 2004 to 2006.

These rises have been reflected in the rate at which mortgages have been set.

They have particularly hurt those with poor credit ratings or on low incomes, who had been sold sub-prime home loans when borrowing costs were cheap.

A Congressional committee report said last week that up to two million US families - especially those considered risky lenders - could eventually lose their homes as borrowing cost rises filter through and lenders become more choosy as to whom they lend to.

Many analysts had taken the view that more rate cuts would be necessary to relieve the pain of higher borrowing costs on house buyers and consumers, which account for a critical two-thirds of US gross domestic product.

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