US Federal Reserve cuts over night interest rates by 75 basis points

THE US Federal Reserve has cut interest rates by 75 basis points to bring down the overnight rates to 2.25 in the FOMC meeting held on Tuesday. Prior to that on Friday there was a cut in the rate of interest by 25 basis points in the wake of the rescue effort through concerted action in the case of Bear Stearns that set off a big sell off in US markets,

The US Central Bank has observed that the “outlook for economic growth has weakened further” and “downside risks remain”, which means that further rate cuts is an option for Fed ,if situation further warrants. The Fed also cut the discount rate at which it provides emergency finance by 75bp to 2.5 per cent.

Inflation has been elevated and some indicators of inflation expectations have risen,” the Fed said. It said policymakers expected inflation to moderate but believed “uncertainty about the inflation outlook has increased”.The Fed’s decision reflects policymakers’ determination to signal that while they are focused on fighting growth risks, inflation still continues to be their worry and if they cut rates too far, the bond market could rebel, pushing up long-term interest rates and, with them, mortgage rates, which offsets the measures taken so far.

This is in addition to US central bank aggressive measures to boost the supply of liquidity to markets, including a new emergency finance facility for investment banks to ward off recessionary trends in the economy. Stock markets have reacted with a typical desperation for good news to post highest increase in 5 years, which peters out within no time. For these rallies to be sustained the overall economic indices should stabilize and the earnings reports should come positively.

Taking a cue of this we can expect a positive impact on the bourses, but it will be sustainable by evening is any body’s guess. The outlook for the Indian bourses continues to be not so positive in the short run and investors would do well not to read too much into these “ temporary gyrations”.