Fed's rate peg disappoints panicky investors

The Federal Reserve disappointed panicky investors last night when it resisted calls for a confidence-boosting rate cut and left US borrowing costs on hold at 1.25%.

Despite hopes on Wall Street that Fed chairman Alan Greenspan would act to put a floor under sliding share prices, the Fed left its so-called policy "bias" in neutral, signalling that it saw no need for a rate change in the near future.

Mr Greenspan appeared to be pinning his hopes on a short war in Iraq, allowing US business to get back to normal. "Oil price premiums and other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses," the Fed's open markets committee said in a statement.

"However, the committee believes that, as those risks lift, the accommodating stance of monetary policy plus growth in productivity will support an improving economic climate."

The no-change decision followed a rollercoaster day on the nervous London markets and Wall Street The Dow Jones, down 142 points in early trading, had rallied before the announcement and by late afternoon was showing a gain of 20 points.

Despite the Fed's calm, analysts said there was rising anxiety about the economic cost of a war on Iraq, which many now regard as inevitable after President Bush's hawkish state of the the union address on Tuesday night.

Renewed war jitters also prompted a sell-off of the dollar and sent gold - the traditional investment in troubled times - soaring towards six-year highs.

The gloom in the US was compounded by claims from independent number-crunchers in Congress that President Bush can expect to oversee fast-rising budget deficits. Calculations by the congressional budget office now show a deficit of $199bn for 2003 - up from the $145bn it forecast in August - and $145bn in 2004, up from $111bn.

Concern about the impact of a war in Iraq was echoed in Germany, where the government downgraded its growth forecast for this year from 1.5% to a weak 1%, but warned that a war could depress the economy even further.

"A possible military intervention in the Middle East could have lasting negative effects on international financial markets, oil prices and consumer and business sentiment," it said in its economic report. "A war would pose incalculable issues that cannot be taken into account in the annual forecasts."

Economists at Bear Stearns said Germany could fail to grow at all if a war pushed up oil prices and sapped consumer confidence.

In London, the general gloom was reflected in sales of Isas and other retail investment products, according to figures published yesterday.

Net sales of unit trust Isas fell from £6.7bn in 2001 to £4.8bn last year as retail investors took fright at the stock market. Many of those people who continued investing sought a haven in corporate bond funds, which accounted for more than a quarter of sales.