US interest rates cut to 45-year low

The Federal Reserve last night signalled that it would not risk Japanese-style deflation gripping the world's biggest economy when it cut interest rates in the United States to their lowest level in 45 years.

America's central bank warned that deflation posed a bigger threat to the health of the US economy than inflation as it justified the quarter-point reduction in interest rates to just 1%, a level not seen since 1958.

In a move that may trigger similar action by the Bank of England next month, the Fed expressed disappointment at the sluggish pace of recovery following the swift and successful ending of the war against Saddam Hussein.

Weak durable goods orders yesterday were the latest evidence that the US is struggling to return to the high levels of growth seen during the boom years of the late 1990s.

A steady rise in unemployment over recent months and low levels of inflation had left Wall Street convinced that the Fed's chairman, Alan Greenspan, would cut rates for the 13th time since they peaked at 6.5% three years ago, but there was some disappointment that the Fed had decided against a deeper cut and was reluctant to use so-called "unconventional measures" such as buying back government bonds in order to reduce long-term interest rates.

In a statement, the Fed said that the unanimous decision by all 11 voting members of its open market committee had been taken to provide an insurance policy for growth.

It added that the previous cuts in interest rates, coupled with strong productivity, were helping to underpin growth, and that there had been signs of a pick-up in spending and an improvement in the stock market.

"The economy, nonetheless, has yet to exhibit sustainable growth. With inflationary expectations subdued, the committee judged that a slightly more expansive monetary policy would add further support to an economy which it expects to improve over time."

The Fed statement was non-committal about whether rates had now bottomed out, noting that there would be both upside and downside risks to sustainable growth over the coming quarters.

"In contrast, the probability, though minor, of an unwelcome substantial fall in inflation exceeds that of a pickup in inflation from its already low level. On balance, the committee believes that the latter concern is likely to predominate for the foreseeable future."

Jack Caffrey, strategist at JP Morgan, said: "I think the 25 basis points is a slight negative as a lot of people have been talking about the prospects of a fire break with a 50 basis point cut.

"The shift in the bias to where the balance of risks is equal is also going to be perceived as a slight negative. People were looking for them to maintain an easing bias."

On Wall Street, the Dow Jones industrial average dropped by 50 points following the announcement in Washington of the Fed's decision, but it then stabilised and was only 17 points adrift an hour before the close.

Paul Cherney, analyst at S&P Marketscope, said: "I think the move by the Fed was more or less what the market wanted. Some may have wanted 50 basis points, but there's little improvement to the monetary situation for the Fed to give anything more than a quarter. What's 50 basis points going to do when you're at rock bottom? The real problem markets face is that corporations don't want to take advantage of the lower rates to spend more and create jobs.

"What the market will look for now is signs of earnings improvement in the July earnings season," he said.