Fed makes 10th rate cut

The US Federal Reserve last night cut interest rates for the 10th time this year in a fresh attempt to revive the recession-stricken American economy and warned that further cuts in the cost of borrowing might be needed to dispel the deepening gloom caused by September's terrorist attacks.

Paving the way for similar action by the Bank of England and the European Central Bank later this week, the Federal Reserve reduced its key federal funds rates by half a percentage point to 2%, its lowest level since 1961.

"Heightened uncertainty and concerns about a deterioration in business conditions, both here and abroad, are damping economic activity," the Fed said in a statement explaining that the third reduction in rates since September 11 pushed an already flagging US economy over the edge into contraction.

With figures out last week showing the economy shrinking, consumer demand falling and unemployment rising, the Fed said that the "risks are weighted mainly towards conditions that may generate economic weakness".

The unanimous decision of its policymaking committee provided the most dramatic evidence that the Fed chairman, Alan Greenspan, and his fellow central bankers fear that the US downturn could turn into a sustained slump and drag the rest of the global economy down with it.

Amid figures from the eurozone showing rising unemployment in Germany and the service sector across the whole region in recession, the IMF yesterday said there was room for the ECB to follow the Fed's lead and cut rates tomorrow.

Some traders had anticipated only a quarter-percent age point reduction at yesterday's meeting, but with inflation virtually non-existent and both consumer and business demand pared back by the continued threat of further terrorism, the Fed saw no reason to make a decisive bid to boost confidence.

In its statement, the central bank said it still saw weakness, rather than price pressures, as the main threat to the US economy. Despite confidence on Wall Street that the dramatically weakening economy will rebound in the spring - a mood which has propelled the Dow steadily upwards - several leading economic commentators fear that the US could be heading for at least a short period of Japanese-style deflation as consumers desert shopping malls and output slumps further.

The Fed said that the long-term prospects for growth remained favourable, but analysts said the central bank was signalling its readiness to cut rates still further, should gross domestic product continue to shrink, as most private forecasters expect it will, into early next year.

Kathleen Stephansen - head of global economic strategy at CSFB - said the Fed would continue to cut rates, with the cost of borrowing reaching 1% to 1.25% by March next year as the unemployment rate soared to as much as 6.25% in the spring.

Other economists had opted for a smaller interest rate cut now, arguing that the Fed wanted to "keep its powder dry" and put pressure on the US Congress to agree a multibillion-dollar stimulus package to reboot the economy.

The package promoted by President Bush is deadlocked on Capitol Hill by a row between Democrats and Republicans over whether the emphasis should be on tax cuts or increases in public spending.