Analysts say Federal Reserve has fired all shots in its armoury

Shares soared on Wall Street last night, but the dollar tumbled after the US Federal Reserve’s shock decision effectively to cut American official interest rates to zero.

The Dow Jones industrial average jumped by more than 359.61 points, or 4.2 per cent, as markets hailed the US central bank’s landmark move to cut its key Fed Funds rate from a previous record low of 1 per cent to a target range of zero to 0.25 per cent.

The broader-based S&P 500 index of US blue chip shares also surged by more than 5 per cent as investors cheered the Fed’s decision to combine last night’s historic cut in rates with a raft of other ground-breaking steps to combat the economic slump.

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The Fed fulfilled predictions that it would announce extraordinary moves to bolster America’s economy through so-called “quantitative easing”. It confirmed that it will buy up “large quantities” of mortgage-backed securities to try to ease the flow of lending to a slumping US housing market.

In other steps designed to help to drive down commercial interest rates for businesses and consumers towards the near-zero level of official rates, the Fed promised to maintain this for a prolonged period, and that it would look at buying up US Treasury bonds.

Expectations that the Fed would go beyond simply cutting its official rates still more yesterday had mounted since these rates are, in practice, only a target for the cost at which US banks can borrow from each other overnight through the central bank. The true cost of this borrowing had in reality already fallen in the past ten days to as little as 0.14 per cent. In its efforts to jump-start the US economy, the Fed is now more concerned with lowering borrowing costs more widely.

Its announcements had an instant effect in bond markets, with prices for US Treasuries rallying sharply and sending yields – market interest rates – tumbling to record lows. Yields on benchmark ten-year Treasury notes fell to just 2.26 per cent, the lowest since 1951, while those on the 30-year Treasury bond fell to a record 2.74 per cent.

Analysts said the central bank had now fired all its shots. David Ader, of RBS Greenwich Capital, said: “This is the lowest the target rate has ever been. Full stop. End of story. It’s an amazing event, really. This is it. They’ve just ended what the Fed can do here. Monetary policy for this cycle is completed.”

The International Monetary Fund renewed warnings that governments across the West need to do much more to avoid global recession. “There needs to be a comprehensive and broader approach that goes beyond simply the Fed to produce success here,” John Lipsky, the IMF’s first deputy managing director, said.

That view was challenged, however, by David McCormick, the US Treasury Under-Secretary, who said: “Co-ordinated actions . . . have decreased the chances of systemic collapse that appeared all too possible several months ago.”

On currency markets, the dollar sagged against both the euro and sterling. It fell by as much as 2 per cent against the single currency, which surged back above $1.40, to $1.4052. The pound was also driven up by almost 3 cents from its earlier close in London to reach $1.5578 last night.

December 17, 2008
Ian King, Deputy Business Editor

Source: The Times

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