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Fed cuts rates by quarter-point to 1 per cent

25/06/2003 22:37
By Peronet Despeignes in Washington

The Federal Reserve cut its benchmark short-term interest rates on Wednesday by a quarter-point to a new 45-year low, amid mixed signs on the health of the world's largest economy.

The US central bank's policy-making Federal Open Market Committee (FOMC) voted to reduce short-term rates from 1.25 per cent to 1 per cent, in a bid to eliminate the risk of deflation - a cycle of falling prices, profits, payrolls and purchases that has vexed Japan for the past decade and gripped the US during the Great Depression of the 1930s.

Some economic figures have recently shown early and tenuous signs of a slow recovery in the aftermath of the US-led intervention in Iraq.
But other data suggest the economy remains languid. The rebound in consumer confidence in the aftermath of the US-led war in Iraq appears to have stalled, and demand for unemployment insurance claims remains high, suggesting a job market that continues to shrink.

The FOMC concluded that the outlook for the economy remained too uncertainto rule out the risk of deflation altogether, and decided to take out "insurance" to make sure the economy does not veer off its fragile recovery track.
"With inflationary expectations subdued, the Committee judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time," the FOMC's statement said.

Deflation would create new problems and complications for the Fed, which would have limited institutional experience and uncertain tools to deal with the phenomenon if it arose.
Measures of inflation expectations remain well above zero, but they have slipped across the board, a factor driving the push for more "insurance".

The Fed's main concern is that inflation, at present close to 40-year lows, remains too close to zero, making deflation a risk that would be hard to reverse.

Investors have been betting heavily on the prospect of stronger growth ahead, further reducing the cost of capital. This owes to the release of recent reports showing a rebound in measures of wholesale and retail inflation.

The Standard & Poor's 500 index has risen 21 per cent over the past 10 weeks for only the fifth time in three decades, initial public offerings have been bouncing back and debt risk spreads have narrowed.

The developments have signalled to many analysts that the recovery the Fed and economists have been predicting may be under way.

Some economists have made arguments against rate cuts - which might have weighed on the Fed's decision not to cut by a half-point, as some Fed-watchers had expected.