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The Federal Reserve slashed US interest rates to 1 per cent last night in the hope of pulling the economy out of its funk and restoring order to the battered credit markets.
The half-point cut came in response to the collapse in consumer confidence and a slide in
retail spending, the Federal Open Market Committee said in its accompanying statement.
"The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures," it said.
"Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for US exports.
Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."
Concerns about inflation, which once tied the committee's hands, have all but evaporated. It said yesterday that the falls in oil and food prices meant price stability was being restored.
US financial markets had already priced in the latest cut, and investors' attention has increasingly turned overseas, amid expectations of dramatically easing monetary policy around the world.
Kevin Logan, the senior US economist at Dresdner Kleinwort in New York, said that while the Fed's rate cut was important, its effect on the credit markets may be less than the many other programmes put in place to restore confidence and get banks lending to each other again.
"It is important because people expect it, and not to do it would cause consternation in financial markets," Logan said.
"Beyond that, the situation is complicated because money market rates are no longer anchored to the Fed Funds rate in the way that we are accustomed to.
People are more risk-averse and are unwilling to accept the risk of lending, predominantly banks lending to each other. That has thrown up money market rates, despite Fed cuts, and it is why the Fed has created all these other programmes."
Since the start of the credit crisis, the US central bank has dramatically widened its interventions in the markets, taking in a broad array of collateral in order to channel cash to the banks.
Just since the middle of September, when the bankruptcy of Lehman Brothers brought the financial system to the brink of collapse, it has launched three initiatives to restore order to the commercial paper market, where big companies find the short-term loans they need to meet payroll costs and pay supplier invoices.
On Monday this week, the Fed began direct purchases of commercial paper, in a move that significantly eased the pressure on companies.
The total issuance of commercial paper due to be repaid in more than 80 days was a record US$67.1 billion ($113.6 billion) that day, and was US$41.6 billion on Tuesday, after a daily average of US$6.7 billion last week.
And in another sign the credit markets are thawing, the London interbank offered rate, or Libor, that banks charge each other for three-month loans in US dollars, dropped 0.05 percentage points to 3.42 per cent yesterday, its 13th straight drop, according to the British Bankers' Association.
- Independent