Size of cut shocks Wall Street

The Federal Reserve, America's central bank, shocked Wall Street last night when it unveiled an emergency half-point cut in US interest rates to prevent the world's largest economy from sliding back into recession.

In a move which markedly shortens the odds on a reduction in borrowing costs by the Bank of England today, Alan Greenspan, the Fed's chairman, slashed rates to 1.25% - their lowest level since July 1961, the first year of John F Kennedy's presidency.

The reduction, twice as big as most Wall Street analysts had been predicting, was the Fed's response to a wave of recent US economic figures showing the economy's recovery in the first part of 2002 rapidly running out of steam.

Just a day after the victory of the Republicans in the US mid-term elections made an attack on Iraq more likely, the Fed said that the risk of war had been one factor behind the economy's slide, which has picked up pace since the central bank's open market committee last met in late September.

The 12 members of the committee were unanimous in backing the drastic action, whereas only two voted for an easing of policy at the previous meeting.

"Incoming data have tended to confirm that greater uncertainty, in part attributable to heightened geopolitical risks, is currently inhibiting spending, production and employment. Inflation and inflation expectations remain well contained."

Wall Street's response to the news was initially muted, with a rally in share prices capped by the fear that the size of the reduction was evidence of the underlying weakness of the economy. The Dow Jones quickly went into reverse as analysts weighed up the prospect that corporate earnings would remain under pressure despite cheaper borrowing.

The Fed added that its 11 rate cuts during the course of 2001 were continuing to underpin the US economy, and made it clear that it would be prepared to cut rates again should growth remain sluggish and the dole queues continue to lengthen.

"Today's additional monetary easing should prove helpful as the economy works its way through this soft spot. With this action, the committee believes that, against the background of its long-run goals of price stability and sustainable economic growth and of the information available, the risks are balanced with respect to the prospects for both goals in the foreeseable future."

Last night's Fed decision will be followed today by meetings of both the Bank of England's monetary policy committee and the European Central Bank's governing council. Before the US announcement, analysts said the chances of a reduction in the UK from 4% was 50-50, while the ECB was expected to leave rates on hold at 3.25%.

Carol Stone, deputy chief economist at Nomura Securities, described the move as "bold and aggressive".

She said: "There is ample evidence that the economy is dead in the water, and this was the Fed's effort to get it going again."

Peter Boockvar, equity strategist at Miller Tabak, said the move was "an obvious surprise".

He said: "From the Fed's opinion they just got it over with instead of cutting 25 points and going to an easing bias. Stocks will get the benefit of the doubt as there is a lot of stimulus in the pipleline."