There are “few weapons in a central bank’s armoury more nuclear than an emergency 0.75% interest-rate cut”, said Edmund Conway in The Daily Telegraph. America’s Federal Reserve slashed its main interest rate to 3.5% on Tuesday, marking the biggest cut in 26 years and the first inter-meeting reduction since September 11, as global stockmarkets plunged on growing fears of a US recession.
However, stocks remained under pressure as economic worries lingered. Given that a 0.75% reduction had been pencilled in for next week’s Fed meeting, the emergency cut smacked of panic, and could thus unnerve markets further, said RBS’s Neil Parker.
What next for the US…
But the crucial issue is whether this “adrenaline shot to the heart”, as Ed Crooks put it in the FT, can revive the US economy. Don’t count on it. As Richard Bernstein of Merrill Lynch notes, lower rates reduce the price of credit but “cannot force financial institutions to… start or stop lending”, and the same goes for consumers. House-price falls are far from over and with household balance sheets under pressure, over-indebted and savings-short consumers are set to retrench rather than pile on more debt.
Financial institutions have been battered by the credit crunch and more losses are in the offing now that bond insurers are looking shaky. That presages further credit tightening. The previous rate cuts haven’t helped: Merrill’s David Rosenberg noted earlier this week that an average of private sector interest rates was at 6.5% due to tightening credit standards. The shock cut “is no solution”, said Lex in the FT.
…and the UK
In Britain, such dramatic rate cuts are unlikely. As David Prosser points out in The Independent, “no doubt Governor Mervyn King would love to cut rates”. But the bank’s remit is to keep inflation at 2%, rather than oversee inflation and growth, like the Fed. And this week King noted that while the credit crunch was clearly affecting the economy and tighter credit was “unlikely to be short-lived”, inflation could exceed 3% this year.
Rising energy and food prices – food producer price inflation is at a near-15-year high – will push inflation “sharply higher” in the first half, said Capital Economics. And surveys of producers’ price expectations suggest they intend to raise prices “much further” while households expect inflation of 3%, which could put upward pressure on wages. With inflation concerns set to linger, rates are unlikely to fall rapidly this year. No wonder, then, King warned the country to brace itself for a tough year as Britain’s debt binge begins to unwind.