Investors will be keeping an eye on developments at the US Federal Reserve tomorrow with some analysts suggesting it may shock the markets with a surprise cut in interest rates to shore up confidence.
Over the past couple of weeks the large brokerages on Wall Street have been fuelling the notion that a surprise rate cut could be on the cards when the Federal Open Market Committee (FOMC) meets tomorrow.
Such a move, in their view, would be very welcome as it would underpin confidence levels in the financial markets and in the US economy and possibly avert a slump towards recession. The degree of shock that would accompany any such move at this stage would magnify its impact and could help to settle the markets.
The key federal funds target rate currently lies at a 40-year low of 1.75 per cent and follows an aggressive rate cutting policy by the Fed over the past 12 months when rates were reduced from 6.5 per cent. This has lead some experts to dismiss the likelihood of any imminent further reduction in US interest rates but they are unwilling to fully rule it out amid signs that the economy is veering towards a double-dip recession.
Just one month ago the same analysts were tipping a rise in interest rates to unwind the dramatic easing in rates over the previous year. The relentless slide in the stock markets and mounting evidence that points to sluggish economic growth has prompted a U-turn in recent weeks.
Mr Alan McQuaid, chief economist at Bloxham Stockbrokers, believes the dilemma for the US authorities is knowing when to act and avoiding the perception that it is bailing out the stock market.
Amongst those favouring a rate cut in the US are Goldman Sachs and Lehman Brothers. In the past week these firms have rattled the markets with predictions that the Fed would have to lower official rates to 1 percentage point by the end of 2002. Deutsche Bank also shares this view, predicting that rates would fall from 1.75 per cent to 1.25 per cent by year end.
These forecasts are largely based on downgrades in US economic growth estimates for the rest of this year as economists, the markets and policy makers have been surprised by the weakness depicted in economic data issued over the last month or so.
"Whether the cuts predicted by Goldman or others come in or out of the FOMC meeting, surprise is paramount because rate cuts are typically seeh as having the bulk of their economic impact a year or more after the fact. Only in the realm of improving psychology can they have a more immediate effect and that's where the element of surprise is key" according to Mr McQuaid.
Mr Robert DiClemente, an economist at Salomon Smith Barney, suggests that while the abruptness of recent developments may argue against a hasty move by the Fed, upbeat assessments of the outlook for the US economy are continually being reassessed.
"We do not expect the Fed to act this week but the fluid nature of the situation suggests that an early cut cannot be ruled out," he said.
On Friday news that productivity growth had slumped to 1.1 per cent in the quarter between April and June - after a near 19-year record of 8.6 per cent in the first quarter - prompted manufacturers to demand action.
"This slow, jobless, inflation free recovery needs a boost from lower interest rates at the Fed meeting next week," said Mr Thomas Duesterberg, president and chief executive of the Manufacturers Alliance/MAPI.
Bank of Montreal economist Mr Sal Guatieri believes the Fed will opt to hold interest rates at current low levels but adds that any further rate cuts would imply greater insurance against the risk of a double-dip recession.
"If things were to worsen, if stock prices fall further, employment begins to contract or the consumer price index (CPI) moderated, the Fed probably would cut interest rates."
(Additional reporting: Reuters)
