October 31st, 2007, the US federal reserve cut interest rates by a quarter of a point to 4.5%. This follows on from a half point cut, a few weeks ago.
The logic for falling interest rates in the US includes:
- Weak Housing Market – House prices falling, sales plummeting. This negative wealth effect is likely to reduce consumer spending and weaken inflationary pressures.
- Strength of Oil Prices – The US economy is heavily dependent on oil. Higher oil prices, effectively reduce disposable income
- Concerns over Credit Markets. Many financial institutions have been burnt by the sub prime mortgage crisis in America. Lack of credit will harm the economy.
- Fall In Consumer Confidence. The combined effect of these things is to reduce consumer confidence
- Inflation is close to Target
Concerns over Rising Interest Rates
Despite these reasons, there are also factors which may prevent future interest rate falls. These are arguments already have some support. ( Not everyone on the Fed voted in favour of a cut.)
Inflationary pressures still there. There are some reasons to suggest inflation may not be as dormant as people would like to believe. Rising oil prices, rising commodities and the weak dollar, can all contribute to inflation in 2008. This would make future interest rate cuts unlikely.
Weakness of the economy over exaggerated. It is often the nature of the media to exaggerate the impact of the slowdown in the housing market. A slowdown in the Housing market need not necessarily cause a recession. Output in Summer grew at 3.9%. This is remarkably high, given the adverse publicity from the housing crisis.
Personally, I feel that US interest rates may not fall for a while. Although I am a little mystified how the economy can be growing at 3.9% when the housing market is in such dire straights. I would have expected the fall in consumer spending to have had a bigger impact on growth. Maybe in 2008, it will.
At the moment, exporters are benefitting from the weak dollar. At least the US current account deficit should be falling in 2008.