Analysts see rate cut by U.S. Fed tomorrow

Look for the U.S. Federal Reserve to cut interest rates by one-quarter of a percentage point Tuesday as Washington grapples with the growing financial crisis on Wall Street, economists say.

That would mean the Federal Open Market Committee, the key body deciding at what level to set U.S. interest rates, would push lending costs down to 1.75 per cent from the current level of two per cent.

"The market is pricing in a 25-basis-point cut to the Fed funds rate," said Sherry Cooper, chief economist with BMO Financial Group. One hundred basis points equals one percentage point.

BMO's Sherry Cooper says the market expects the U.S. Fed to cut rates by a quarter of a percentage point.(CBC)

Bond holders drove up prices for interest-rate bearing bonds Monday in anticipation of the Federal Reserve cutting rates when it meets on Tuesday.

Economists generally agree that central banks reduce borrowing costs as a way of promoting economic growth.

And many experts now believe the U.S. Fed will be interested in boosting the national economy in the wake of Monday's broker-house meltdown.

The bankruptcy of Lehman Brothers and the discount sale of Merrill Lynch & Co. to Bank of America shook markets at the start of this week and had policymakers scratching their heads looking for ways to limit the financial damage from these changes.

For his part, U.S. President George W. Bush said the inherent strength of the country's financial system will protect companies and the overall economy from the worst effects of the turmoil on financial markets.

"In the short run, adjustments in the markets can be painful both for people who have investments and employees of affected companies. In the long run, I am confident that our capital markets are flexible and resilient and can adjust to these developments," Bush said, speaking at the White House before a news conference with the president of Ghana.

Economists, however, expect the Federal Reserve to be a little more active in its protection of the U.S. financial system.

"Given market developments over the weekend, the Fed will also need to assess the macroeconomic fallout from the ongoing financial market turmoil at [Tuesday's] meeting. This turmoil presents the greater, and more immediate, risk of the cost of capital turning higher," wrote Paul Ferley, assistant chief economist at RBC Economics, in a morning economics note.

"As a result, the outcome of this meeting remains a toss-up between holding interest rates unchanged and cutting Fed funds."

Some market watchers have drawn parallels between the current financial crisis and a similar borrowing hurricane that hit markets back in 1997 after a number of Asian currencies collapsed in value.

At that time, central banks gave markets all sorts of access to financial resources as a way of insulating the larger economy from the financial shockwaves on currency markets.

Experts noted that Wall Street's debacle places less pressure on the Bank of Canada to cut Canadian interest rates.

First, any move by Canada's central bank is likely to have a minimal effect on global capital markets.

As well, reducing Canadian borrowing costs only helps domestic industry and will do nothing to boost consumer and corporate demand in the United States, economists said.

The Bank of Canada's key overnight lending rate currently stands at three per cent.

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