Analysts expect US interest rates to rise after cut to lowest level since 1958
The US central bank has delivered a larger than expected interest rate cut of 50 basis points in the hope it will be the final prop the economy needs.
The Open Market Committee of the Federal Reserve Board lowered its target for the Federal funds rate to 1.25%, the lowest level since 1958, to help the economy through what it described as a 'soft spot'.
It is the 12th time the Fed has cut interest rates since the current round of easing began in January 2001, before which the rate was 6.5%. In a statement announcing the decision, the Fed said it continues to believe an accommodative stance of monetary policy, coupled with still-robust underlying growth in productivity, is providing important ongoing support to economic activity.
It also warned that data has confirmed that greater uncertainty because of geopolitical risks is inhibiting spending, production and employment. It said inflation and inflationary expectations remain well contained and the risks to its twin long-term goals of price stability and sustainable economic growth are balanced for the foreseeable future.
M&G head of retail fixed interest Jim Leaviss said: 'It seems the message they want the market to hear is that they think they have done enough and rates can hopefully stay at this level.'
The Fed also hopes to defuse speculation the rate cut implies panic, he said. 'But with interest rates at the lowest level in around 50 years, that has to tell you something about what they're thinking,' he added.
'They will be desperately worried right now about the state of the US economy, so I wouldn't say this is definitely the last cut we'll see.'
Nonetheless, flattening in the US bond yield curve since the rate cut suggests the market expects the next rate move to be upward.
Leaviss said fixed-interest investors should now be increasing duration and government bond exposure.
'If you believe we've seen the last cut from the Fed then you should be buying the long end of the bond market, because yield curves ought to flatten quite aggressively,' he said.
'If you are very bearish on the economy you will probably be entirely in government bonds, but if you do think they are doing enough right now then it may be time to buy corporates and high-yield bonds.'
Although some have drawn parallels between the Fed running out of policy ammunition and the actions of Japan's central bank, which was unable to foster economic recovery despite cutting its base rate to zero, US companies have greater flexibility in cutting labour and other costs..
Martin Currie Japan manager Michael Thomas said the economic environment in Japan is also different. 'We have price deflation in Japan and an excessive amount of debt,' he said. 'The problem in Japan is there's no demand for money ' debt is not a good thing to have with price deflation. However that has yet to strike the US.'
With the Republicans winning control in both the US Senate and Congress in the mid-term elections, president Bush now has the ability to implement stimulatory fiscal policies.
'They can still do things with the budget, and monetary means include measures to affect the price of money, as they have by cutting interest rates, or the quantity of money,' Thomas said.
Following the Fed move, the Bank of England (BoE) Monetary Policy Committee's decision to hold the base rate at 4% took some by surprise, but Leaviss said the Fed cut makes domestic easing less likely.
'UK growth is going to be sluggish but the Government is pumping a lot of money into the economy, consumer spending is still strong and although industrial production has been weak for a long time, nothing has really changed,' he said.
The BoE's main concern is the global economy but the Fed is already fighting that battle, allowing other central banks to sit tight, although both the BoE and the European Central Bank could still make cuts in coming months, Leaviss said.
Baring Asset Management director of emerging markets John Payne said the US easing should stimulate growth in countries that export to the US.
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