Wednesday, March 19, 2008

Fed cut brings markets back from the brink· Bank urged to follow 0.75 point move

Fed cut brings markets back from the brink· Bank urged to follow 0.75 point move

· UK stocks recoup Monday's losses

Ashley Seager and Larry Elliott The Guardian, Wednesday March 19 2008

Wall Street

The US Federal Reserve put pressure on the Bank of England and other central banks last night to follow its lead in warding off a global economic slump when it cut interest rates for the sixth time since the financial crisis began last summer.

Amid calls from the City and business groups for the Bank to act, the Fed cut its key interest rate by 0.75 points to 2.25% in an bid to restore confidence to Wall Street following the bailout of Bear Stearns.

The move was less aggressive than the one point cut financial markets had hoped for, but was enough to push leading shares sharply higher. The Dow Jones closed up more than 400 points up and the Nasdaq technology market experienced its biggest one-day gain in five years.

In a statement the Fed said "financial markets remain under considerable stress", adding that credit and housing market problems would continue to weigh on economic growth. But concerns over inflation and the recent weakness of the dollar led two of the Fed's open market committee to vote for a smaller half-point cut in interest rates.

Financial markets rallied before the Fed's announcement on hopes that Sunday's Fed-inspired purchase by JP Morgan of Bear Stearns - America's fifth biggest investment bank - would mark the end of the financial turmoil.

Markets are now looking to the Bank of England and the European Central Bank to lower borrowing costs. In the UK rates are still at 5.25% in spite of two recent cuts by the Bank while the ECB has rates at 4%.

Responding to the Fed's decision, George Bush said he remained confident about the US economy. "In the long term we are going to be just fine," he said.

But analysts cautioned that with rates now at 2.25%, the Fed might soon run out of ammunition with which to fight the credit crisis. "At the risk of stating the blindingly obvious, there are only 225 basis points between the current Fed funds rate and zero. There are very few bullets left for the Fed to fire," said Nick Parsons, of NAB Capital.

In London the FTSE 100 gained 3.5%, or almost 200 points to close at 5,606, recouping almost all of Monday's losses. Bond prices fell as investors left safe-haven assets to move back into shares.

The Dow Jones had gained more than 2% in advance of the Fed's announcement on relief that earnings at investment banks Goldman Sachs and Lehman Brothers had not been worse than expected. Goldman's profits were down 53% in the first quarter as it made $2bn in writedowns related to the credit crunch. Lehman's profits were down a similar amount but trading losses were partially offset by strong earnings in its merger advisory division. Shares in both banks rose, especially as Lehman's fell on Monday on fears it could follow Bear Stearns into collapse.

"Goldman's report was good and Lehman's wasn't the end of the world," said Sal Arnuk at Themis Trading in New Jersey.

Bear Stearns shares rose as investors bet that a rival bid could emerge for the bank JP Morgan agreed to buy at the weekend for just $2 a share. Bear's shares jumped as high as $8.

But the euphoria was dented by figures showing another fall in US housing starts last month where the origins of the credit crunch lie.

Analysts at Morgan Stanley in New York said that pointed to a further drop of more than 10% in house prices in the coming year, which would represent a 25% fall in two years. The rapid fall in house prices has left many properties worth less than the mortgage taken out on them and is the main reason why credit markets are deteriorating nine months after the crunch began.

Henry Paulson, the US treasury secretary, and a former head of Goldman Sachs, said the economy was in "sharp decline" but continued to resist using the word recession.

"There's no doubt that the American people know that the economy has turned down sharply. To me much less important is the label that's placed on it today. Much more important is what we do about it," he said.

Oil prices were more subdued yesterday after achieving a record high of $111.80 a barrel on Monday. The price rose by about $2 over the day to nearly $108. Gold closed in Europe at just over $1,000 an ounce, having set a record of $1,033 on Monday.

In the UK inflation rose to a nine-month high of 2.5% last month from 2.2% in January, well above the Bank of England's target of 2%. The Office for National Statistics ascribed this to a change in the way it put rises in electricity and gas bills into the figures, but economists said the rise complicated the Bank's task of cutting interest rates .

The British Chambers of Commerce, though, urged the Bank to forget inflation for the time being and cut rates in April.

Figures over the next day or two could be crucial in making up the monetary policy committee's mind. These include unemployment and wage growth data today followed by key retail sales figures tomorrow.

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