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Fed expected to lower key interest rate

Text by AFP

Latest update : 2008-10-27

Ben Bernanke, President of the Federal Reserve is expected to announce on October 29 another cut in the US key interest rate. A cut to 0.75 per cent, though dramatic, could reinvigorate market investment.

The Federal Reserve is widely expected to cut key interest rates further at its upcoming two-day meeting, hoping to offer a psychological boost to panic-stricken financial markets, analysts say.
The US central bank, which led a coordinated global rate cut earlier this month that pushed its target rate down a half-point to 1.50 percent, is seen as trimming the rate another 25 to 50 basis points.
The Federal Open Market Committee headed by chairman Ben Bernanke is expected to announce a decision around 1815 GMT Wednesday at the close of a two-day meeting.
Yet analysts say the move would be largely symbolic because the actual rate of overnight interbank loans is in fact well below the Fed target because of the extraordinary efforts to pump liquidity into a strained banking system.
"The cut is already in the market," said John Ryding, economist at RDQ Economics.
Ryding said a fresh rate cut is virtually certain "and the question is whether it's 25 or 50 basis points."
Still, Ryding said the Fed target rate is largely "irrelevant" during the current market turmoil, with the actual overnight rate since October 16 between 0.60 and 0.93 percent for these types of interbank loans.
On Friday, the futures market was implying an 86 percent chance of a half-point cut in the funds rate to a historic low of 1.0 percent and a 14 percent chance of a cut of three-quarters of a point that would leave the rate at 0.75 percent.
"The market is convinced the Fed will do something," said Cary Leahey, senior economist at Decision Economics.
"We lean toward 25 basis points but we wouldn't be surprised to see 50. I think there would be resistance to lowering the rate below 1.0 percent."
Cutting below 1.0 percent could be seen as a sign of panic, according to some analysts, and also would remind markets of the low rates in 2003 that fueled the massive housing market bubble. Also, a low funds rate could pressure some investment firms' money market funds, which might be unable to pay interest to investors after management expenses.
Joseph LaVorgna, economist at Deutsche Bank, said he expected a half-point cut that "should embolden some investors to take risk" that would help ailing markets.
"Hopefully, the combination of excess liquidity and government guarantees will encourage investors to extend further out on the money market curve," he said.
Avery Shenfeld, senior economist at CIBC World Markets, said turbulent financial markets will be looking for something from the Fed to calm the intense volatility.
"With so much bad news already built in, there’s nothing to fear but fear itself," he said.
Shenfeld said the market will likely get more downbeat economic news, and that under the circumstances, "We see the Fed as having no reason to go light on its rate cut."
"So while we favor a 50 basis point move as more likely than a 25 point trimming, markets may worry that the central bank is running out of ammo," Shenfeld added.
Leahey said the Fed will remind markets that it stands ready to take further actions if needed to stabilize conditions.
With rate cuts largely ineffective, the central banks could buy longer-term Treasury bonds in an effort to "twist the yield curve" and bring down rates affecting mortgages, Leahey said.
Fed members "feel that righting the economic and monetary ship is job number one," Leahey noted.
"They'll make sure they will remind investors they will not stand down till the job is done."

Date created : 2008-10-26