Tougher Action By Fed Possible

Source : The Straits Times, Aug 20, 2007

Central bank may have to cut key fed funds rate if fallout from sub-prime crisis worsens

FEDERAL Reserve chairman Ben Bernanke could be forced to cut the central bank's key lending rate within days, if last Friday's rally on Wall Street fails to stop the fallout from the sub-prime crisis.

Analysts say the Fed's surprise move to slash the discount rate - the interest rate charged on its loans to commercial banks - is welcome, but it is no panacea for the fundamental problems US markets are facing.

Investors are still hankering for a cut in the more important federal funds rate that would lower borrowing costs on everything from school loans to mortgages, and help the broader economy.

Mr Craig Alexander, chief economist at TD Bank Financial Group, believes a cut in the fed funds rate, which affects the broader economy, is just around the corner.

'The discount rate reduction is telling, as it strongly signals to markets that the Fed is prepared to ease monetary policy if the credit crunch does not dissipate soon,' he said.

Economists said the accompanying Fed statement reveals a seismic shift in the bank's risk hierarchy that puts economic growth above inflation.

'It is ...opening the door to a cut in the target federal funds rate,' wrote analysts at Global Insight, betting on a half-point cut to 4.75 per cent at the next scheduled Fed policy-setting meeting on Sept 18. Other analysts say they expect only a quarter-point reduction.

But there are some who predict that the central bank will leave its key rate unchanged.

By Sept 18, 'financial conditions may have normalised to such an extent that the Fed can hold monetary policy steady', said Mr John Lonski of Moody's Investors Service, although he said the prospects are slim.

Meanwhile, stock markets could see fresh turbulence because the extent of the credit crisis remains unclear.

Hedge funds and investment banks are still wrestling with credit problems spawned by distressed sub-prime mortgage loans. The housing market still looks gloomy.

Wall Street observers say there is still plenty of risk out there and that the aftershocks from the failure of billions of dollars in sub-prime loans have yet to be felt. - AGENCE FRANCE-PRESSE, ASSOCIATED PRESS