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US Fed may cut rates to zero: economists -

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US Fed may cut rates to zero: economists

The World Today - Thursday, 30 October , 2008 12:10:00

ELEANOR HALL: But first to the dire economic signs coming from the United States. The US central
bank this morning slashed official interest rates to a half-century low in an attempt to cushion
the economy, which is almost certainly heading into a deep recession.

The Federal Reserve cut its benchmark interest rate by half a percentage point to just one per
cent.

It is the second reduction in a month and several economists are now predicting that the central
bank could even cut rates to zero.

Business editor Peter Ryan has our report.

PETER RYAN: Today's one percentage point cut is the latest move to prevent a recession in the
United States - adding to coordinated global rate reductions, massive liquidity injections, bank
bailouts and in some cases, nationalisations.

Dramatic action is an understatement - but economists wonder if anything is working.

RORY ROBERTSON: The Fed has cut its funds rates from five and a quarter to one and the
disappointment for the Fed so far is that the predominant mortgage rate over there, which is a
30-year fixed-rate mortgage, it has been about six per cent the whole way through.

So for all the Fed's efforts to support the economy with lower rates, the key interest rate in that
economy, the predominant mortgage rate, has basically settled at sort of six, six and a half per
cent.

PETER RYAN: Rory Robertson is an interest rate strategist at Macquarie Bank. He says the US economy
is in such dire straits that rates could fall as low as zero.

RORY ROBERTSON: I think that the US economy needs all the help it can get and I think there will be
quite a big debate within the Fed over coming months about whether it would make sense for it to
cut below one per cent.

One per cent is where is got back in the early 2000s recession. I think it doesn't really want to
go below one per cent but the size of the recession and the size of the problems in the US economy
might actually force it to do what they had been doing in Japan for a while.

PETER RYAN: Is there a real possibility though that rates could go to zero?

RORY ROBERTSON: Sure, sure. That is what they are there for. The Fed funds rate simply is a tool to
be used to help manage the economy.

The simple rule is, when unemployment is falling, the Fed tends to increase its Fed funds rate and
dampen wage and price pressures. When unemployment is rising sharply, it tends to cut its funds
rate.

It has been doing that now for a year. It has come from five and a quarter per cent all the way
down to one and if this deepening recession that is unfolding in the US right now, the Fed may be
forced to cut further.

PETER RYAN: Another economist Roger Kubarych agrees the gloomy outlook could see rates plunge.

ROGER KUBARYCH: It is certainly technically feasible. It will depend on the numbers. It will depend
on the stock market and whether there are any more big business failures that will completely wreck
consumer confidence.

PETER RYAN: Roger Kubarych says there's a precedent for rates going below zero if the world falls
into recession.

ROGER KUBARYCH: Don't forget the Swiss did a negative equivalent of federal funds in the 1970s.
They had imposed a tax on bank deposits at the Swiss national bank so the effective interest rate
for a big Swiss bank, putting money in the Swiss national bank was negative.

PETER RYAN: With rates now at the lowest in 50 years, commentators are updating their analogies as
the market worries central bankers have exhausted their collective bags of tricks.

COMMENTATOR: Don't people on the market get a little bit freaked out when rates come down this low,
because you know, if you are in gun fight and you have only got one bullet left, it is a little bit
of a scary situation.

PETER RYAN: But the chief economist at Credit Suisse, Neil Soss, says the cutting has to stop
sometime, and that the Federal Reserve needs to revise its strategy.

NEIL SOSS: There needs to be, at some point pretty soon it seems to me, articulated an exit
strategy. Something that doesn't treat the financial system as an emergency ward of the state but
rather something that says, OK, you are out of the intensive care unit. Now you are in a
rehabilitative phase and some day we are going to let you out of the hospital.

PETER RYAN: Investors are now turning their attention to tomorrow's official growth numbers, which
are expecting to show the US economy is close to flat-lining in a prelude to recession.

Matthew Zeman is a futures trader based in Chicago.

MATTHEW ZEMAN: If those numbers come out poor, it is going to kind of snap everybody back to
reality and kind of away from this euphoria that we have seen the last two days. I think the market
is going to continue to focus on the fundamentals and you know, we need to see continued
improvement in the credit markets as well.

PETER RYAN: With interest rates sliding in the United States, the question is what will Australia's
Reserve Bank do when they meet next week?

RORY ROBERTSON: I am guessing the Reserve Bank is going to cut by half a point next week.

PETER RYAN: Macquarie Bank's Rory Robertson believes that after this month's one percentage point
cut, there's a long slide down.

RORY ROBERTSON: The Reserve Bank took six years to lift its cash rate from four and a quarter per
cent to seven and a quarter per cent so a six year tightening phase in gradual steps. My guess is
that the Reserve Bank will reverse all of that tightening within a year.

So the first cut was in September. I think that by next September we will see Australia's cash rate
down to say four and a quarter per cent.

PETER RYAN: But any dramatic cuts could be limited, with inflation still running at five per cent.

The deputy governor of the Reserve Bank Ric Battelino said in a speech this morning that Australia
can avoid a recession but he suggested that the inflation "overhang" will remain a key issue in the
setting of Australia's monetary policy in the months to come.

ELEANOR HALL: And that is business editor Peter Ryan.