Rate cuts may not be <CW-2>enough to avert recession

The Federal Reserve and the European Central Bank are likely to win many plaudits for their decision to cut interest rates yesterday. But as the US equity markets continued to sink last night, it remained unclear if their action would succeed in avoiding the calamitous slides feared by many.

The rate cuts did succeed in stabilising the currency markets but could not calm nerves on what was always going to be a fraught day.

This was the first time that the ECB cut interest rates between meetings and proves that the Bank is capable of taking action in a crisis - even if such action has been unprecedented until now.

The aim of the rate cuts was to provide some economic stability along with injecting billions in additional liquidity into the global financial system.

The move could ultimately also mean a sharper upturn in economic fortunes - admittedly after a much sharper downturn in growth than many had predicted.

This scenario is reliant, however, on the impact of unfolding developments on oil prices.

So far the US administration has been putting substantial and sustained pressure on its major allies within OPEC to allow prices to drop through the bottom of the $25-$30 (€27.2-€32.7) per barrel range that they have maintained this year.

The idea is to get prices down as low as possible before military action and any resultant tick upwards.

If this strategy works then it will be good news for both the US and European economies. But if retaliation were to disrupt the oil supply - perhaps as a result of a war in the Middle East - then all bets would be off.

The main concern in the meantime is the likely response of American consumers to last Tuesday's attacks. Spending by them has been sustaining the US economy but they may opt now to reduce their expenditure on goods ranging from cars to houses.

By timing the rate cut to coincide with the first day of resumed trading on Wall Street, the ECB is likely to avoid criticism of its failure to reduce rates earlier. The Bank has only recently admitted that it underestimated the extent of the impact the US slowdown would have on the European economy.

Limited early falls in equity markets were attributed to some extent to the massive moral persuasion being used by many not to let the terrorists drive down stocks. US Treasury Secretary Mr Paul O'Neill said on Monday the US economy would recover despite inevitable disruptions caused by last week's attacks.

And on NBC Television before trading was due to resume in New York, he exhorted investors to "buy American" as he sought to rally confidence.

But the decline in the markets later in the day underlined the longer term uncertainty with further volatility expected in the weeks ahead.

What does seem clear is that both the Fed and the ECB are likely to be in rate-cutting mode for the remainder of this year. According to Mr Oliver Mangan, economist at AIB, US interest rates may fall another half percentage point to 2.5 per cent with European rates falling a similar amount to 3.25 per cent by the end of the year.

He said this would not help deter the immediate prospect of a US recession, which appeared inevitable, but should make a recovery possible by next summer.