Recession fear forces hand of US central bank

Pressure grows on world's largest economy

BY Larry Elliott and Ashley Seager

08/18/07 "The Guardian" -- -- The Federal Reserve, America's central bank, made a dramatic intervention to support share prices yesterday as it took fright that this week's meltdown in global financial markets could tip the United States into recession.

In a move that surprised the markets, the Fed responded to the week-long battering of stocks by cutting one of its key interest rates to help banks. It hinted that it might cut its main base rate to help homeowners and businesses next month.

Earlier this week, one of the Fed's key policy makers, Bill Poole, had said it would take a "calamity" to force it into an emergency base-rate cut but it opened the door to such a move yesterday when it expressed concern about the fallout from panic-stricken global markets.
The move prompted an immediate surge in share prices in the City, and relieved dealers turned a 40-point fall in the FTSE 100 at lunchtime into a 205 gain by the close of business. It ended at 6064.2 points - a slight gain on the week.

Wall Street also made hefty early gains, rising more than 300 points at the opening, but concern that the Fed had been forced into action by a looming downturn in the economy or a yet-to-be announced problem for a major financial institution later reduced the surge. The Dow Jones industrial average was up almost 150 points by lunchtime in New York.

Overnight, stock markets in the far east had suffered fresh losses amid concerns that exports to the US would be hurt by the crash. With the American economy counting for more than 20% of global demand, a recession there would have knock-on effects round the world, especially on countries in Asia which supply flat-screen TVs and computers to US consumers.

The Fed cut its "discount" rate - the rate at which it will lend to commercial banks - by half a percentage point to 5.75% in an attempt to oil the wheels of the global banking industry.

The Fed, whose chief Ben Bernanke had been under severe pressure to act all week, also said the outlook for the US economy had worsened - something dealers described as a coded warning that it would be prepared, if necessary, to cut its main interest rate from its current 5.25% level when it next meets on September 18.

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth," the Fed said.

In a concerted European effort to talk up the markets, Alistair Darling sought to soothe fears that growth in the UK would be jeopardised by the market turmoil. "The UK economy is strong and stable. The global economy is also strong at this time," the chancellor said. He added, however, that there was "certainly an argument" for greater transparency in markets and noted this would be discussed by G7 nations in the coming months. Finance ministers in France and Germany issued their own messages of reassurance.

City analysts disagreed over the significance of yesterday's rescue bid. "The Fed will now do whatever it takes to re-establish financial stability. The worst is now over," said Sherry Cooper, chief economist at BMO Capital Markets.

Diana Choyleva, economist at Lombard Street Research, said markets still did not know the full extent of the losses from the US sub-prime mortgage sector - loans to uncreditworthy borrowers that have turned sour.

"Investors and lenders alike are scrambling to figure out what the size of the problem is and whether they are exposed to it. There is no authority on the global scene to come out with a credible estimate of the overall exposure," she said.