Fed cuts US interest rates by a quarter point

The US Federal Reserve cut interest rates by a further quarter point yesterday following signs that the economy was weakening and inflation was under control. The Fed trimmed the key federal funds rate at which banks lend to one another overnight from 5.5 to 5.25 per cent.

Shares had dropped in advance of the Fed meeting due to profit-taking. After setting records for three days running, the Dow Jones index had fallen almost 30 points before the Fed's decision. The dollar had eased nearly half a pfennig against the mark to DM1.4870 after the German move.

Wall Street's earlier surge this week had reflected mounting hopes of an interest rate reduction as economic activity continued to disappoint and inflationary pressures subsided. Although some analysts were still cautious about whether the Federal Reserve would act today or wait until its next meeting in March, a slightly disappointing December figure for factory gate prices yesterday did nothing to dent the financial markets' hopes.

Prices charged by manufacturers rose 0.5 per cent last month, mainly due to a recovery in energy prices from an earlier dip. The "core" prices measure, excluding food and energy, rose only 0.1 per cent in the month and 2.5 per cent in the year to December.

Christopher Low, an analyst at HSBC Markets in New York, said: "This figure will not worry the Fed one iota about inflation."

Nor did it offset the impact on market sentiment of earlier news of a dismal Christmas for retailers and a drop in consumer confidence to its lowest level for nearly two years.

The Bundesbank cut its main money market interest rate, the repo rate, from 3.55 to 3.4 per cent yesterday, the fourth reduction in as many weeks, and a bigger fall than expected.

The move came despite news of faster-than-expected growth in M3, the Bundesbank's monetary target, earlier in the week. Analysts said it showed the authorities' concern with the economic slowdown.

Hopes of an early reduction in the discount rate, which sets the floor for other interest rates, were revived. Dietrich Beier, an economist at Bankgesellschaft Berlin, said: "It shows the Bundesbank has no reason at all to hit the brakes."

The Bundesbank reduced the discount rate by half a point to 3 per cent on 14 December. The US Fed last cut its key Federal funds rate by a quarter point to 5.5 per cent on 19 December.

The international trend towards lower interest rates contributed to the success of a gilts auction in Britain. There were total bids of pounds 5.9bn for the pounds 3bn worth of stock up for auction, and the "tail" between the average and highest yield was a narrow two basis points.