The US Federal Reserve yesterday cut interest rates by half a percentage point, saying the deterioration in the US economy called for a "rapid and forceful" response, and signalled it would act again if needed.
The decision was welcomed on Wall Street where it had been widely anticipated. Retail banks responded almost immediately by cutting their prime lending rates by a similar margin to 8.5 per cent.
The need for a rate cut was underscored by more bleak news on the US economy yesterday. The US Commerce Department revealed that growth in the final quarter of 2000 fell to the lowest level in five years. Having already cut rates by half a percentage point on January 3rd, the US central bank has now lowered the overnight bank lending rate by a full percentage point in one month for the first time. The last full point revision was in 1984 when rates were increased. "Consumer and business confidence has eroded further, exacerbated by rising energy costs that continue to drain consumer purchasing power and press on business profit margins," the Federal Reserve open market committee said in a statement announcing the cut after a twoday meeting in Washington. "Partly as a consequence, retail sales and business spending on capital equipment have weakened appreciably. In response, manufacturing production has been cut back sharply, with new technologies appearing to have accelerated the response of production and demand to potential excesses in the stock of inventories and capital equipment.
"Taken together, and with inflation contained, these circumstances have called for a rapid and forceful response of monetary policy. The longer-term advances in technology and accompanying gains in productivity, however, exhibit few signs of abating and these gains, along with the lower interest rates, should support growth of the economy over time.
Federal Reserve chairman Mr Alan Greenspan warned the US Senate budget committee last week that growth for the current quarter was "probably very close to zero". He said the underlying cause was weakness in consumer spending. The US Commerce Department announced yesterday that growth for the final three months of last year fell to 1.4 per cent, its weakest performance in more than five years. This represents a dramatic slowdown since the second quarter of last year, when the economy grew by 5.6 per cent rate. While car and computer sales have fallen, there was some heartening news for the economy yesterday in the property market. The Government said that sales of new homes rebounded sharply in December. The 13.4 per cent sales increase, the biggest monthly gain in more than seven years, left sales for all of last year at 898,000, down 1 per cent from the all-time high of 1999, but still the second-highest sales total on record.
On Tuesday, the consumer confidence index fell sharply, underlining Mr Greenspan's concerns and making an interest cut inevitable. In a related action, the Federal Reserve cut the discount rate on direct Fed loans to commercial banks by half a point to 5 per cent. The January cut erases all the rate rises of 2000.
"The extent and the suddenness of the slowdown has caught everyone by surprise," said Mr Oscar Gonzalez, economist with John Hancock Financial Services. "This isn't a crash, but certainly is a sudden jolt."
