BBC Monday, 20 August, 2001, 20:08 GMT 21:08 UK US rate cut on the cards

Federal Reserve Chairman Alan Greenspan hopes yet another rate cut will jump start the flagging US economy By BBC News Online's North America Business Reporter, David Schepp

As the US central bank weighs its rate-cut strategy on Tuesday, it does so in the shadow of an economic slowdown that has now spread beyond the United States and begun to grip Europe.

In recent weeks, economists have been taken aback as the economies of Germany and Italy slowed to a crawl, defying predictions of growth in Europe offsetting a slowdown in the US.

At Tuesday's meeting of Federal Reserve officials, an interest rate cut is all but assured.

"The economy is not really sinking but we're just treading water," says Robert Dederick, economic consultant to Northern Trust in Chicago. "Until the Fed really sees evidence that things are turning around, they will be predisposed to ease."

It is the proof of an economic revival that will have market watchers keenly eying the Fed's comments at the conclusion of Tuesday's Federal Open Market Committee (FOMC) meeting.

Tricky time

It is a tricky time for the American economy. Some economic data points to considerable slowing despite consumers' willingness to keep buying.

Indeed, it has been the Fed's goal in introducing its interest rate cuts to keep American consumers spending, as business clamps tight its wallet amid a technology meltdown.

Also of concern to some investors is the recent erosion in the strength of the US dollar against the world's major currencies. The strong dollar has been responsible for a flurry of foreign investment in the United States.

That is one reason for the weakening dollar, according to David Bowers, chief global investment strategist at Merrill Lynch.

"The US economy is highly dependent on foreign capital," Mr Bowers told BBC News Online.

"It has been foreigners' willingness to fund the biggest private sector borrowing boom the US has ever seen that has enabled US domestic demand to grow at a 5% [annual growth rate] between 1996 and 2000."

Quarter-point cut

It is widely believed the Fed will issue another cut of 25 basis points, or a quarter point, on Tuesday, adding to a string of reductions it has implemented this year.

All of the cuts with the exception of one have been half-point cuts. Following its June meeting, however, the Fed elected to reduce the Federal Funds rate, the amount banks charge one another for overnight loans, by just a quarter point.

If another quarter-point cut emerges on Tuesday, the Fed Funds rate would fall to 3.5%, the lowest it has been since February 1994, when it stood at 3.25%.

Market turmoil

Stock markets in the US have had nearly two months to digest the most recent rate cut and to mull future rate reductions.

For this reason, stocks are expected to react little to the expected quarter-point cut.

Despite the lowered cost of borrowing money and consumers' seemingly unstoppable appetite for goods - especially housing, Wall Street has endured a losing year.

For the year, the Dow Jones Industrial Average is down 5%, while the Nasdaq Composite, heavily comprised of technology stocks, has slipped nearly 25%.

Declines such as these have led some analysts to give up on 2001 and start focusing on next year.

Greenspan's shadow

While most of the doom and gloom is the responsibility of corporations issuing profits warnings, Fed chairman Alan Greenspan's comments have also added to the pessimistic mood among investors.

Mr Greenspan sent shivers through financial markets after Congressional testimony in July. Mr Greenspan said the American economy still faced considerable uncertainties, and interest rates might need to be lowered further.

"Pressures on profit margins have been unrelenting... weakness is evident virtually across the board," he said.

Mr Greenspan's comments have cast a long shadow on Wall Street, which is why market watchers are anxious to hear what the Fed has to say.

While the US may be under pressure to lead the world out of the downturn, according to Merrill Lynch's Mr Bowers, "If the Fed set monetary policy for anything other than what was appropriate for domestic America, that [would be] a difficult situation to handle."

It would appear the Fed remains solely focused on turning around the US economy.

-- Anonymous, August 21, 2001