Fed holds firm on rates

The US federal reserve admitted last night that the threat of war against Iraq could derail the fragile recovery in the world's largest economy, although it resisted calls for a confidence-boosting rate cut.

On a day when share prices on both sides of the Atlantic took another pounding, Britain's main FTSE 100 index closed down 68.3 points at 3,671 points, its lowest finish since December 1995.

Disappointment over the Fed's decision to keep rates on hold at a 40-year low of 1.75% prompted a further bout of selling on Wall Street after the London market had closed. The Dow Jones industrial average was trading down 132.56 points at 7,739.59 after the Fed decision.

Mounting concern about the likely economic fallout from America's collision course with Saddam Hussein and a string of companies warning of disappointing conditions ahead fuelled the rout.

"Needless to say, traders, analysts and market observers are clean out of confidence, and it is going to take a PR exercise of gargantuan proportions to change investors' minds," said David Buik at Cantor Index.

In a statement accompanying its decision, the Fed warned that the heightened international tensions could knock America's recovery off course. It said the US still faced a greater threat of renewed economic weakness than of resurgent inflation, a sign it is prepared to step and cut rates if necessary.

In an unusual move for a commission used to unanimous decisions two members of the 12-strong federal open market committee, dissented from the no-change decision, preferring an immediate cut.

"The Fed is telling us they are concerned about the pace of economic growth, but the real challenge is going to be if something happens in the Middle East," said John Silvia, chief economist at Wachovia Securities. "From their point of view a geopolitical shock would lead to a significant double-dip risk and they don't want to go down that road."

Stalling growth was also a concern in Europe where the European commission has admitted that member states will be unable to meet the stiff targets agreed with Brussels for closing their budget deficits.

Bowing to pressure from governments, the commission has given countries a two-year extension from the original deadline of 2004.

After months of insisting that member states must balance their budgets by 2004, the commission's president Romano Prodi said yesterday's concession reflected "complicated and different circumstances".

Two of the biggest Wall Street banks added to the gloom when they warned that conditions continued to worsen.

Goldman Sachs and Lehman Brothers said the weakening confidence in the economy, the trail of corporate scandals and sluggish company profits meant there was little hope for improvement in the near term.

Goldman said conditions "had actually worsened" in the bank's third quarter. The firm's corporate finance division, which advises on mergers and acquisitions and share issues, reported $652m (£418m) of revenues, down from $1.1bn a year ago. The bank has reduced headcount by 9% so far this year to 20,647 and said that further job losses are on the way.