Fed has little room to keep cutting rates, European central banker warns

Section:

By Ambrose Evans-Pritchard
The Telegraph, London
Monday, January 14, 2008

http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/01/14/bcnfed...

Rumours of an emergency rate cut over coming days by the US Federal Reserve have swept the global markets, setting off a fresh plunge in the dollar.

Gold surged to an all-time high of $914 an ounce in New York on bets that the authorities will flood the global system with further liquidity to stave off a mounting debt crisis.

Ashraf Laidi, a currency expert at CMC Markets, said futures contracts were starting to price in a serious likelihood of a half-point cut before the next scheduled meeting at the end of January.

"With US equity indices testing their August lows and current macro-economic dynamics knocking at the door of recession, we place the probability of a 50-basis-point inter-meeting rate cut as high as 70 percent to occur as early as next week."

But Lorenzo Bini-Smaghi, a member of the European Central Bank's executive council, warned that the tumbling dollar may now start to foreclose the option of US rate cuts and force the Fed to keep monetary policy tighter than it would like.

"I would not be so sure about the movements of the Fed. There is a serious problem with the dollar in America. We will see what margins they have for further rate cuts," he told Italy's La Repubblica newspaper.

It is the first time that a top central banker has openly aired concerns that dollar weakness could constrain US economic policy.

Until now Washington has largely been able to ignore the currency, treating the slide as a headache for the rest of the world.

The euro briefly touched $1.49 today, just shy of its all-time high.

A leaked client note by HSBC added fresh fuel to the rate excitement, suggesting that Fed may now have to slash a full percentage point by month's end to fend off a serious downturn.

The bank's highly-rated New York economist, Ian Morris, said a new tone of urgency had been struck by top US officials over recent days, raising the possibility of two sets of cuts this month.

Fed chair Ben Bernanke prepared the way for drastic cuts with a speech on Thursday saying the authorities were "exceptionally alert" to the risks as the housing slump triggers the first wave of jobs losses. US unemployment jumped from 4.7 to 5 percent in December, the sharpest jump in a quarter century.

US Treasury Secretary Hank Paulson said the administration is rushing to craft a fiscal stimulus package to boost spending. "Time is of the essence," he said.

HSBC said the Fed had now raised expectations so far that it risks setting off fresh "financial stresses" if it fails to deliver a serious shot in the arm.

"If the Fed were to cut inter-meeting, we think it would by 50 basis points, followed by another 50 basis points on the 30th," HSBC said. The bank said this is a possibility, not a hard forecast.

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