Fed likely to go for a rate cut

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Sep 30: The Federal Reserve may need to consider dipping further into its toolbox as Congress tries to revive legislation aimed at rescuing banks.

One of the main remaining options for Fed chairman Ben S Bernanke to cushion the economy and shore up confidence in financial markets is cutting the benchmark interest rate, according to economists. A reduction could be coordinated with other central banks, they said.

US stocks plunged the most since the 1987 crash on Monday after the House of Representatives rejected a bill containing treasury secretary Henry Paulson's $700 billion plan to buy distressed debt. The Fed has already lowered its main rate 3.25 percentage points since the start of the crisis and set up $1.4 trillion in emergency borrowing for banks and other institutions.

“It certainly increases the chance of us going to 1.50 in short order” from the current 2% benchmark rate, said Keith Hembre, chief economist at Minneapolis-based FAF Advisors Inc, which oversees $112 billion. “Unemployment is likely to continue rising, I think the inflation pressures are dissipating very quickly, and you've got turmoil in the financial markets.”

“Those all argue for another rate cut,” said Hembre, a former Minneapolis Fed researcher.

Besides lowering rates, the Fed may not have many options beyond further expanding emergency lending programmes or creating new ones, using the central bank's balance sheet, economists said.

The bailout legislation — backed by Bernanke — isn't dead yet, and Paulson and congressional leaders are still working to pass it after House members rejected it by a 228-205 vote. The Senate may take up the bill as early as October 2. “We need to work as quickly as possible; we need to get something done,” Paulson said on Monday after meeting with President George W Bush.

Hours before the House vote, the Fed said it will flood banks with cash, pumping an additional $630 billion into the global financial system.

The Term Auction Facility, the Fed's emergency loan programme for commercial banks, will expand by $300 billion to $450 billion.