Page last updated at 16:21 GMT, Tuesday, 16 December 2008

US rate cut towards zero expected

US Federal Reserve chairman Ben Bernanke
Mr Bernanke has been discussing other policy options that may be used

US interest rate-setters, led by Federal Reserve chairman Ben Bernanke, are expected to cut rates from the current level of 1% on Tuesday.

They are expected to lower it at 1415 EDT (1915 GMT) to 0.5% or even 0.25%.

As they run out of room for further cuts, the policymakers may give details of what other tools they plan to use.

Other possible measures include buying debt backed by home loans, in the hope of halting the dramatic decline in the housing market.

Deflationary threat

It was problems with mortgage-backed debt that set off the problems in the US in the first place, but the Federal Reserve may decide that increasing demand for it could help to stimulate the economy.

Graph of US interest rates

A central bank printing money to inject into the markets is a strategy known as quantitative easing, which was pioneered by Japan as a way of battling its own deflationary problems in the 1990s.

Deflation becomes a greater risk as interest rates head towards zero.

It can be a problem because if people believe that prices are going to fall then they have incentives to postpone buying anything they can, which means there is even less activity in the economy.

Federal Reserve chairman Ben Bernanke discussed quantitative easing in a speech at the beginning of this month.

Fresh weakness

"Our nation's economic policy must vigorously address the substantial risks to financial stability and economic growth," he said.

The Federal Reserve has already been doing some quantitative easing with the billions of dollars it has been pumping into the financial markets, through emergency loans to banks and other institutions.

The Federal Reserve's key rate, the target rate for overnight federal funds, has been cut drastically from the 5.25% where it stood in September 2007.

There were signs earlier on Tuesday that there is scope for the central bank to cut interest rates without worrying too much about the threat of inflation.

Consumer prices dropped by 1.7% in November, according to the US Labor Department, following a decline of 1% in October.

Much of the decline came from continuing falls in oil prices, which are $100 a barrel off their July peaks.

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