| | Did Fed rock the boat?
Unexpected rate cut may make situation worse in UK, says investor
Thursday • September 20, 2007
Edmund Conway
The United States Federal Reserve cut interest rates by half a percentage point in what was seen as a desperate bid to avert a Northern Rock-style banking crisis engulfing the United States. Northern Rock — one of the United Kingdom's largest mortgage lenders — asked the Bank of England for help last week, after it faced cash flow problems following the global squeeze on credit.
The unexpected Fed decision heaps extra pressure on the Bank of England to reduce British borrowing rates, as economists count the cost of the credit crunch.
But it also raises hopes that this will bring a swift end to the credit crisis that has enveloped markets around the world and pushed up borrowing costs.
As a result, it is thought that British mortgage interest rates, which recently hit a nine-year high, could start to fall. Share prices are expected to be catapulted higher in London, as investors celebrate the return of cheaper money to the markets.
Federal Reserve chairman Ben Bernanke's move came 24 hours after Chancellor Alistair Darling took the unprecedented step of bailing out Northern Rock by guaranteeing all the savings in the high street bank.
The US interest rate cut was described as an "aggressive" attempt to put a stop to the credit crunch — the original cause for the near-collapse of Northern Rock. It came amid signs that the crisis was abating, with queues outside the high street bank shrinking and share prices recovering. Northern Rock said the panic was easing, with only four of its 76 branches reporting queues.
However, economists warned that while the moves on both sides of the Atlantic may stave off the crunch for another year or so, they would mean the next crash would be even more emphatic.
Prime Minister Gordon Brown insisted that the economy remains in a strong position, as politicians and experts warned that the crisis could cause a high street slump and send the housing market spiralling downwards.
In his first comments on the bank run, the PM said Britain had "an economy that will continue to grow, continue to create jobs and continue to have low inflation and low interest rates.
"The decisive action we have taken means that the deposits of Northern Rock customers are guaranteed. It is because of the strength of our economy that we have been able to take these measures."
He blamed America for the market crisis, which has pushed mortgage rates higher, squeezed households and ultimately caused the near-collapse of Northern Rock. "This is a set of financial problems that have happened in America, spread to Germany and Europe and now we are seeing some instances of that in Northern Rock in the United Kingdom," Mr Brown added.
It is this crunch, in which banks have stopped lending to one other, which caused Northern Rock to ask for emergency funding from the Bank of England.
The Federal Reserve's cut to 4.75 per cent — the first in four years and the biggest since 2002 — was greater than most experts had expected. It came after a shock fall in employment last month, which stoked fears of a recession.
The cut may be seen as a warning to the Bank of England, which faces similar problems with high levels of household debt and a property market seen to be even more overvalued than America's.
After the move, the dollar fell against all major currencies, dropping to an all-time low against the euro. The pound vaulted above the $2 mark within seconds.
Mr Jim Rogers, a renowned investor and former partner of Mr George Soros, said the Fed's decision was a grave error. "Every time the Fed turns around to save its Wall Street friends, it makes the situation worse. The dollar's going to collapse, the bond market's going to collapse. There will be a lot of problems in the US," he said.
The writer is economics editor at The Telegraph. |
