Banks poised to reduce rates again

The world's central bankers will try their best to boost confidence this week against a background of unremitting gloom. First up will be the US Federal Reserve led by Alan Greenspan, who has emerged as America's most authoritative economic voice in an administration short of figures of real economic clout.

As the Fed meets tomorrow, Mr Greenspan is cast in the role of the cavalry riding to the rescue as the world's largest economy finally sinks into recession after 10 years of uninterrupted growth, the longest boom in US history.

Mr Greenspan has done his damnedest to keep the American economy afloat, by cutting rates since the beginning of the year in a pre-emptive campaign to avoid a hard landing. Already beginning to slow at the beginning of 2001, the US economy shrank by an annual rate of 0.4% in the third quarter and is set to contract further in the present quarter. That would put the US into recession - defined as two consecutive quarters of no growth.

The Fed is widely expected to cut rates by a half-point to 2%, the lowest since 1961, amid expectations that rates will come down to 1% next year. But there are limits to what the cavalry can do and despite the rate cuts, there is little confidence that Mr Greenspan's efforts will put American back on the path to growth any time soon. Most economists expect the US unemployment rate, which sank to 3.9% 13 months ago, to hit 6% next year, its highest level for the first time since 1994.

On Thursday, the Bank of England and the European Central Bank are also expected to follow the US lead. Easier to read than the ECB, the Bank of England is widely expected to lop off another quarter-point to bring rates down to 4.25%, the lowest in 30 years.

Through a combination of good luck and sound economic management, Britain is best-placed to weather the economic turbulence ahead. For this year, the world's fourth-largest economy is expected to meet its target of between 2.2% and 2.5% and while growth will taper off next year, the UK is expected to be the fastest-growing member of the G7 group of industrialised countries.

But as the chancellor, Gordon Brown, noted yesterday, Britain cannot stay immune from ripple effects from the US and Europe. Figures released today from the Office of National Statistics underlined his point. It reported that Britain's manufacturing sector recorded its biggest monthly production drop in almost a decade in September as it sank deeper into recession.

The slump in manufacturing coincided with a weak report on activity in the services sector, which far outweighs manufacturing in terms of UK economic activity. The report from the Chartered Institute of Purchasing and Supply showed that key services business index activity fell to 46.3% in October from 48.1% in the previous month.

October's figure was the worst since the survey began in July 1996, so the warning signs for the UK economy are there. The Bank of England has little choice but keep on cutting rates.

So we come to the ECB, the most problematic of the central banks. The ECB has passed up several opportunities to cut rates in recent months, much to the despair of eurozone politicians who had hoped that Wim Duisenberg, the ECB president, would take as proactive a stand as his US counterpart in the face of the global slowdown.

But the ECB remains obsessed by inflation, even though recession is the paramount threat facing the continental European economies. Growth is at a standstill in Germany, although as Avinash Persaud, an analyst with State Street, the US financial services company, notes, it would be incorrect to equate Germany with the eurozone.

"France is unlikely to be in recession," says Mr Persaud, who, like many in the City, expects the ECB to cut rates by 0.25% on Thursday.

ECB board member Eugenio Domingo Solans today hinted at a rate cut, when he said the ECB expected the outlook for inflation would improve as the eurozone economy slowed and interest rates would respond accordingly.

"I think the bank is prudently taking into account, basically as a priority, inflation, but of course, without ignoring that, there is an economic slowdown here that translates into better inflation expectations and that also has to have - of course, is having - its response in interest rates," Mr Solans said in Madrid.

As far as the ECB goes, which has a done a poor job of signalling interest rate moves, that seems to indicate that this time it will not disappoint policy makers as it has done so in recent months. With the world economy gripped by uncertainty, the ECB would do well pitch in with the Fed and the Bank of England to boost confidence.