Fed set to cut rate by up to 50 points, albeit reluctantly

THE FEDERAL Reserve will probably end up cutting interest rates by as much as 50 basis points by the end of its policy meeting tomorrow, but it will do so without any great conviction.

Senior policymakers do not think that reducing the federal funds rate from its already low level of 1.5 per cent will have a big effect on financial markets or the US economy.

They do, however, think further rate cuts in other big industrialised economies are urgently needed.

This might make them amenable to a second transatlantic co-ordinated rate cut, if other central banks expressed an interest.

However, such a co-ordinated cut could undermine efforts to stem the yen's sudden rise.

Fed officials think that, in the US, the interest rate is now a secondary issue.

They believe the main tools to fight the economic downturn are now government capital injections and asset purchases, plus giant central bank liquidity operations including borderline unsecured loans.

Fed officials no longer worry about rate cuts boosting commodity prices, and are less concerned about the dollar.

But they worry about the potentially harmful effect on confidence if the Fed fires off all its ammunition now and it has little apparent impact.

Some officials are uncomfortable about cutting rates below 1 per cent - the lowest rate reached during the deflation scare at the start of this decade.

Meanwhile, yields on commercial paper rose as the Fed began buying the debt directly from companies, showing the central bank's efforts to unfreeze short-term credit markets have yet to take hold.

Rates on the highest-ranked 30-day commercial paper, which many large corporations use to finance their day-to-day operations, jumped 25 basis points to 2.88 per cent.

The Fed created its programme to buy 90-day commercial paper directly from issuers three weeks ago in hopes of reviving demand after the market seized up with the bankruptcy of financial giant Lehman Brothers. This had prevented many borrowers from selling anything but overnight paper. - (Financial Times service/ Bloomberg)