Fed cuts rate to 'virtually zero'

Stunned economists had been expecting the US Federal Reserve to cut the key interest rate to 0.5 per cent

From Times Online

December 16, 2008

Gary Duncan, Economics Editor

Read Federal Reserve statement in full

US interest rates were cut to a historic low of virtually zero as America resorted to drastic action in its battle to stave off a crippling recession and deflation.

Wall Street shares soared after the Federal Reserve, the powerful US central bank, stunned markets by cutting interest rates from an already 50-year low of 1 per cent to between zero and 0.25 per cent.

The unprecedented move to combat a slump that threatens to turn into a Thirties-style Depression far exceeded a more modest half-point rate cut to 0.5 per cent predicted by experts.

It came alongside a raft of other ground-breaking steps as the Fed fought to kick-start the stalled American economy.

The aggressive measures will turn up heat on the Bank of England, criticised for being slow to react in the present global crisis, to take more far-reaching action to shore-up Britain’s floundering economy.

Offering a grim assessment of rapidly worsening US conditions, the Fed pledged to us “all available tools” in its campaign to prevent economic calamity on the scale of the Depression.

As well as slashing its official interest rate, at which US banks can borrow from each other overnight, the Fed acted to drive down wider commercial borrowing costs for American consumers and businesses, pledging to keep official rates at “exceptionally low levels ... for some time”.

In another extraordinary measure it said it will make huge purchases of mortgage debt from US banks and lending groups to try to ease the home loan drought that is fuelling a runaway slump in American house prices.

The central bank is also to consider still more radical moves to ensure that commercial interest rates are driven down through the mechanism of buying up US Government bonds.

The Fed explained its moves by painting a bleak view of the US economy. It pointed to falls in consumer spending, business investment, and production at American factories. Financial markets were strained and borrowing conditions still tough.

On Wall Street, the US stock market hailed the sweeping Fed programme by sending shares surging. The Dow Jones industrial average leapt by 359.6 points, or 4.2 per cent in New York to close at 8924.14.

But the dollar slumped as the new, ultra-low US rates spelled lower returns for money deposited in US. The dollar’s losses drove the euro back above $1.40 to $1.4052. The pound also jumped by almost 3 cents to more than $1.55.

The landmark Fed decision came after fears of a vicious deflationary spiral taking hold in the US — sustained falls in prices across an economy — were stoked by official figures showing that a record drop in prices last month cut headline American inflation to just 1.1 per cent.

Overall US consumer prices nosedived by 1.7 per cent in November, registering their sharpest monthly fall in record. This cut the annual US inflation rate to just 1.1 per cent last month — less than a third of the 3.8 per cent pace in October.

While the collapse in US inflation was driven by plummeting energy costs, with motor fuel costs slumping by 29 per cent last month alone, economists said there were rapidly emerging signs of more broad-based falls in consumer prices that flashed warning signs over a dangerous bout of deflation. “Core” US consumer prices, excluding energy and foods costs, were unchanged last month, and in the latest three months were up by just 0.4 per cent from levels a year before, the weakest such rise for five-and-a-half years.