US rate cut hopes get stronger

Will the US Federal Reserve cut its key rate to salvage an economy that could well be slipping into a slowdown or will the world's most powerful central bank wait for the groan to get a little louder before moving in with the rate cut dosage?

According to a NewsWire18 poll of 15 economists and treasurers, chances of a reduction in U.S. interest rates at the Federal Open Market Committee's rate setting meet on Sep 18 appear bright as a series of data show the economy could be losing steam.

This includes disappointing non-farm payroll numbers in August, which showed a decline for the first time since 2003. Jobs fell by 4,000 last month, while numbers for June and July were also revised sharply downwards.

This led to fears that a slowdown in the housing sector is now spilling over to other segments and could decelerate overall growth in the world's largest economy.

The US central bank's key federal funds target rate is currently at 5.25 per cent. The global currency, equity, and bond markets have already factored in a quarter percentage point cut, analysts said.

"With the labour market showing signs of weakness, the Fed will respond and highlight risks to growth," said Gaurav Kapur, senior economist at ABN AMRO Bank.

Kapur expects 25 basis points cut next week followed by another similar cut in October.

"The economy will take a deep dive if they don't cut (interest rates) now," said Vikas Goel, executive director of treasury and money markets at Calyon Bank.

"The Fed's policy will be (shifting) focussed on financial stability from inflation and inflationary pressures."

In a statement following the 50 basis points cut in the discount rate to 5.75 per cent in August, the FOMC had said downside risks to growth have increased appreciably. "Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the statement had said.

Calyon Bank's Goel expects a further 25 bps cut in the discount rate to 4.50 per cent next week.

In a speech, also last month, Fed Chairman Ben Bernanke warned that if the credit crisis arising from deterioration in sub-prime housing sector was sustained, it could adversely affect consumer spending and the overall economy.

"Inevitably, the uncertainty surrounding the (growth) outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives," Bernanke had said.

Some treasurers also expect an aggressive 50 basis point interest rate reduction by the Federal on September 18.

"We have revised our forecast to a rate cut in September from October," said Sundeep Bhandari, head - global markets of South Asia at Standard Chartered Bank.

"The payroll numbers are pretty bad and highlight the downside risk to the growth outlook. We are expecting a 50 bps cut next week."

BNP Paribas' treasurer Manoj Rane also agreed it was possible the Fed would slash rates by half a percentage point to 4.75 per cent.

"If the Fed is more aggressive than 25 bps, then it should not surprise markets."

Treasurers and economists believe that a cut in interest rates next week would be the start of further decreases to support an economy that could slip into recession.

"We are expecting three cuts totalling 75 bps between now and end of the calendar year. The Fed funds will be at 4.5% by year-end," said Rajeev Malik, executive director - Asia economic research at JP Morgan Chase Bank. Standard Chartered's Bhandari also expects a quarter percentage point cut each in October and December.

"The weakness in housing and credit crunch underway poses stiff headwinds for the economy," said Prasanna A., fixed income analyst at ICICI Securities adding that the Fed will implement a series of cuts going forward.