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US Fed brings up emergency rate cuts

Channel News Asia Prime Time Morning
23 January 2008

US Fed brings up emergency rate cuts

Synopsis
The US Federal Reserve slashed interest rates by 75 basis points in an attempt to stop the US economy from falling into recession. It is the first emergency rate cut since the 9-11 attacks. Group Managing Director to Spire Research and Consulting, Mr Leon Perera, gives his comments:

“The benefit of the rate cut is that it sends a very strong signal to the markets that this Fed under Bernanke is extremely pro-growth. They’re very focused on growth – they’re willing to take some risks in terms of inflation because inflation numbers have gone up in December but we still see a very aggressive rate cut. The effect then on consumer and business sentiments might be positive… although it will not be a silver bullet.

I think the trend in US GDP is negative and it’s broad-based. It has gone beyond the financial sector – employment numbers have been very poor, retail sales in December contracted by 0.4 percent, consumer credit card defaults have been going up. So I think the indications are very clear that the contingent from the sub-prime mortgage has hit the generalized economy very hard and we’re expecting the Q4 ’07 GDP figure to be somewhere between 0 to 1 percent… and Q1 to Q2 ’08 to be slightly negative. I don’t think the Fed rate cut would be able to avert a recession but it may help to lift short-term sentiment to some extent.

The two central banks that can probably make the most difference would be the European Central Bank (ECB) and the Bank of Japan. The ECB is historically much more conservative than the Fed so I don’t see a great deal of cutting going forward. The Bank of Japan doesn’t have very much to cut as interest rates are already very low in Japan. So I suppose we would see some degree of cutting on the European side but not nearly as aggressive as what the Fed is doing…

Inflation rates for December are slightly worrying. The Fed has been historically targeting a core rate of inflation – that is the rate of inflation that strips out food and energy prices – between 1 and 2 percent. And it had been between the 1 and 2 percent range for quite some time. But what happened in December is that the core rate actually jumped to 2.4 percent and the general CPI was 4.1 percent. So there’s some risk that we will move into a situation where growth is negative and inflation is creeping up, which is the nightmare stagflation scenario.

On balance, I think the Fed was right to prioritize growth concerns over inflation concerns, given the sharp decline in economic indicators that we saw in December and given the depth of the housing crisis – the worst collapse in house prices in the US since the Second World War – so the 75 percentage point cut was not considered too aggressive. But what the Fed really needs to do is look closely at those inflation numbers before cutting further as move through the year… a further 1 percentage point cut over the remainder of the first half of this year is very likely.

Asia is better-equipped now than it was five or ten years ago [to withstand any fallout from the US recession]. Domestic drivers of demand in Asia are strong, particularly from the giant China and India economies. In the ASEAN region we see consumer spending being well-supported and in Australia we also see domestic demand to be strong. So I think there are some good domestic sources of growth in Asia.

If we look at the US recession in 2001, the three economies most affected were basically Singapore, Hong Kong and Taiwan. These are open economies that export a great deal to the US, particularly in electronics which is a very cyclical sector. So I believe Singapore, Hong Kong and Taiwan will again be the worst hit in Asia. We don’t see, for instance, China, India or Australia, really having the growth hit by more than 10 percent or thereabouts from what is going on in the US.

Having said that, there are other reasons to be concerned about the Asian growth outlook that have nothing to do with the US. There will be something of a stock market correction and this is because such a correction is overdue to the bull run in equities that we’ve seen since ’05. Also the China A shares are going to see a downward correction this year and that will affect stock markets in the rest of the region. There is also some concern over property prices in China and India, so I think there are certainly some reasons to be concerned about Asian growth. But in general, Asian growth will not be too badly affected by what’s going on in the US.

Going forward, we expect the Dollar will weaken before it gains ground. So there will be more downside against most of the currencies in Asia, less of course for the case of China and Hong Kong, but more for others. We expect to see some recovery in the US Dollar exchange rate to Asian currencies as it gets to the end of the year, depending on what happens in the US economy.”

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