Worries about corporate profits prompt US rate cut

THE UNITED States cut interest rates again yesterday, because of continuing worries about the financial health of America's corporations.

The Federal Reserve announced a quarter-point cut in the Federal Funds rate, taking it to 4.75 per cent from 5.0 per cent, and a surprise quarter- point in the discount rate, from 4.75 per cent to 4.5 per cent. This is the third reduction in the Fed Funds rate in two months, following the Fed's summer shift from concern about rising inflation and wage trends to worries about flagging growth and a liquidity crunch.

"Although conditions in financial markets have settled down materially since mid- October, unusual strains remain," the Fed said in a statement accompanying the cut.

There are still worries that the difficulties in lending markets which forced the hedge fund Long Term Capital Management to the wall might hurt other financial sector companies. At the same time, despite continuing growth and a slight rise inflation, the Fed sees no risk of an inflationary spiral.

"Financial conditions can reasonably be expected to be consistent with fostering sustained economic expansion while keeping inflationary pressures subdued," it added.

Though the market had been anticipating a cut in interest rates, cheers rang out from the floor of the New York Stock Exchange as the news was announced. The US economy is still growing at a good pace, according to the most recent data, but there are concerns that corporate profits are down and investment is flagging. The Dow Jones Industrial Average had been down about 70 points before the announcement, but it jumped sharply as the news came through to stand about 30 points higher, at 9,041.

The rate cut came on the same day as a very timely report from the Organisation for Economic Co-operation and Development, which predicted a further decline in borrowing costs. It said that the Fed would reduce rates to 4.5 per cent during 1999, and anticipated further declines if the global economy continued to show signs of distress.

The Fed cut rates at its September meeting by a quarter point, which disappointed the market, then delivered another surprise cut of a quarter point just over two weeks later, also reducing the discount rate.

"These cuts appear to have restored some liquidity to capital markets after the precipitous fall in new issues of equity and below-investment quality bonds in the summer," the OECD said. It expressed concerns about the prospects for the equity market, warning that the likely forecast for corporate profits was poor.

"With labour costs running ahead of prices, the fall in profits could accelerate, raising the risk of a drop in equity prices and a significant fall in investment," the OECD warned. "The reaction of financial markets to lower profits will be critical. Another drop in the stock market could depress consumer sentiment further and push the economy towards recession."