Wednesday, September 19, 2007

Why Did the Fed cut US interest rates by 0.5%?

1. They are concerned about the economy slowing down and possibly heading into recession. - Is US economy heading towards recession?

2. The main concern in the US economy at the moment is the state of the Housing Market and sub prime mortgage industry. Mortgage defaults are on the rise and US Housing prices are falling. The Fed is concerned that problems in the Housing market will spread to the rest of the economy. If house prices fall, people feel less wealthy and less confident. Therefore, there is a reduction in consumer spending. - Boom and Bust in US Housing Market

3. By cutting interest rates, they have reduced the cost of mortgage payments. This should help to increase disposable income of homeowners. It will also help reduce the number of mortgage defaults, which are causing severe problems for the US banking industry (and indirectly causing problems for UK banks like Northern Rock.

4. Economic Growth has slowed down in the US, inflation is below target.

5. Current Account deficit may improve. The US has a very large current account deficit (just under 7% of GDP) cutting interest rates will weaken the dollar, helping US exports become more attractive. This may reduce the current account deficit. Although, it is worth pointing out this is not the main reason that the FED cut interest rates (the deficit has been large for a long time)

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