Page last updated at 01:57 GMT, Tuesday, 29 April 2008 02:57 UK

US rates tipped for one more cut

Fed chairman Ben Bernanke
The Fed is watching inflation risks, fuelled by high oil prices and a weak dollar

The US central bank, the Federal Reserve, is widely expected to trim interest rates to 2% from 2.25% this week to lift the troubled US economy.

Policy makers will begin their two-day meeting later amid signs that economic growth has stagnated, or even shrunk.

It is thought that this could be the last cut for a while, after bold action from the Fed and White House has led to hopes that the worst could be over.

Rising inflation risks could also lead to a rate cut pause, analysts say.

"We expect this to be the last cut, but the Fed will be flexible in responding to economic conditions," said Peter Berezin, global economist at Goldman Sachs.

Pause imminent?

The Fed has been slashing rates - on occasion between its official meetings - to bring them down from their peak of 5.25% last summer to their current level of 2.25% amid increasing signs that the US is sinking into a recession.

The only part of the policy transmission mechanism that is working is the weaker dollar helping to sustain solid export growth
Ethan Harris, economist, Lehman Brothers

But rate cuts take a number of months to have any effect and the Fed has voiced hope they could help to spark a recovery in the second half of the year.

It has also been lending billions of dollars to banks that are wounded from the sharp fall in the value of investments linked to the slumping US mortgage market and keen to sit on their cash.

This has caused the sharp increase in the rate that banks charge each other for money, which many have passed on to their customers in the form of higher mortgage rates and personal and business loans.

Meanwhile, the first of $100bn of tax rebates to cash-strapped US households were sent out on Monday as part of an economic stimulus package passed by Congress and signed into law by US President George W Bush in February to boost flagging consumer spending.

In view of these measures, combined with the risk of rising inflation, the Fed is likely to be cautious about further aggressive downward moves, analysts say.

Balancing act

The Federal Reserve, like its UK and European central bank counterparts, faces a fine balancing act between lifting the heavy financial strain on banks, businesses and consumers to encourage economic growth - and keeping the lid on spiralling inflation.

With oil prices at near $120 a barrel and the cost of staple foods, including wheat, corn and rice, vaulting ever higher, the Fed is likely to be paying close attention to inflationary pressures, analysts said.

"The Fed's hope that falling oil prices will ease inflation pressures looks something of a remote one at this time," said John Ryding, Bear Stearns chief economist.

"In short, fears of inflation are likely to limit the Fed's generosity on the rate front and we only expect a quarter-point cut on 30 April," he added.

But others highlight a gloomy government report on new US home sales for March, with sales the lowest since 1991 and prices tumbling by 13% on the previous year, and argue that the Fed cannot afford to stop cutting rates - though perhaps at a slower pace.

Ethan Harris, an economist at Lehman Brothers, considers that rates could fall to 1.25% by next year.

"The only part of the policy transmission mechanism that is working is the weaker dollar helping to sustain solid export growth," he said.

"The other channels of policy - market interest rates, asset prices, and bank lending - are either clogged or working in reverse," he added.

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