Fred Rate Cut

Another notch down

The Fed cuts interest rates again

FAINT-HEARTED or far-sighted? On October 31st the Federal Reserve gave financial markets what they had wanted and expected: a quarter-point cut in the federal funds rate, to 4.5%. Despite some internal misgivings and one outright dissenting vote, the central bankers decided that the risks to America's economy warranted slightly cheaper money.

The logic is simple enough. Credit markets, though not as chaotic as in the late summer, are still fragile. And the outlook for the economy has darkened in recent weeks as the housing bust has deepened. The pace of home-building is plunging; big falls in applications for building permits suggest more declines ahead. House prices are falling too. The latest figures from the S&P/Case-Shiller index of 20 big cities suggest that the average house price in August was 4.4% below its level a year before. Consumers are feeling nervous. One widely watched index of consumer confidence fell for the third month in a row in October, to its lowest level in two years.

Add soaring oil prices to the mix and there is a real risk that Americans will slow their spending sharply, dragging the economy down. At the same time underlying inflation seems broadly under control. The Fed's favoured price index, the core personal consumption expenditure deflator, which excludes food and fuel, rose by 1.8% in the year to the third quarter.

These are all sensible arguments for lower rates. Nonetheless, this week's decision carries risks. One is tactical. The Fed has validated the impression in financial markets that investors' expectations drive the central bankers' decisions. It has done nothing to dispel the idea that if Wall Street clamours loudly enough for a rate cut—and futures markets price one in with any degree of certainty—the Fed will oblige. The Greenspan put has in effect been replaced by the