Interest Rates set to fall further 

The headline in our last note was, 0.75% Fed Rate Cut: Prudence or Panic? The jury is still out on that question, particularly as it emerged that some of the sharp market falls that appeared to have prompted the rate cut may have been as a result of Soc Gen unwinding their “rogue trader” positions, however there has been lots of other news flow for us to think about since then. 

Further US Rate Cuts

The week after the emergency rate cut the Fed had its regular monthly meeting and made the additional 0.5% cut that had originally been penciled in, which again initially seemed to cheer the markets. 

In the US it appears that the Fed has given up all pretence about being concerned with inflation in the face of a rapidly weakening economy as the latest Consumer Price Index (CPI) figures are running at 4.1%, well ahead of target. This seems more understandable though when you look at just how rapidly economic growth is slowing, so the Fed may be right not to worry about inflation, which should fall of its own accord during a slowdown. However they are wrong we may see a return of stagflation, slow growth with rising inflation, but this is a topic worthy of a separate note. 

But Europe doesn’t look so bad?

Certainly the ECB doesn’t think so as it steadfastly refuses to lower interest rates as CPI remains above target at 3.1%. Nonetheless the bank’s tone has become less hawkish as concerns of a spillover from the US slowdown grow.  

This is reflected in the latest 4^th quarter GDP figures from the Eurozone, which indicated that growth had slipped back to 0.4%, or an annualised 1.6%, below recent trends. Furthermore Germany and France slowed markedly, while the Mediterranean states are in no position to pick up any slack as their debt fuelled economies are already struggling. As a result a number of analysts believe that the ECB will be forced to cut rates sooner rather than later. 

And the UK?

There seemed to be a lot of disappointment when the BoE cut only 0.25% off base rate at the beginning of February as markets worry about UK growth in the face of the larger global slowdown, however at the moment the UK economy appears to be robust, despite our horrendous debt overhang. This apparent strength combined with the inflationary pressures of increasing commodity prices and a weakening currency have prompted the Governor of the BoE to indicate that he is concerned that CPI could actually increase from its current level of 2.1% (against a 2% target) to over 3% during 2008. 

While this is possible it seems likely that growth will slow dramatically this year, with some commentators, such as the Times’s Anatole Kaletsky, rapidly moving from a fairly bullish outlook to very bearish and perhaps for good reason. The highly lopsided nature of the U.K. economy is being exposed. Discretionary consumer spending peaked in the third quarter of last year and is set to slow rapidly (see chart) on the back of what appears to be a likely housing bear market. In addition, sub-prime mortgage problems are possibly worse in the U.K. than in the U.S. and layoffs in finance and business services, which account for 30% of GDP, have yet to really bite. Other components of GDP are unlikely to compensate. The credit crunch is starting to strangle capital expenditures, tough spending ceilings are curtailing government outlays and a slowing euro area economy is blunting the benefits of sterling weakness to exporters.

As a result of this we would not be surprised to see that towards the end of the year the BoE will, like the Fed before it, be rapidly forced to cut rates more aggressively regardless of the short term inflation outlook.

And Finally 

It got crowded in heaven, so, for one day it was decided only to accept people who had really had a bad day on the day they died. St. Peter was standing at the pearly gates and said to the first man, "Tell me about the day you died."

The man said, "Oh, it was awful. I was sure my wife was having an affair, so I came home early to catch her with him. I searched all over the apartment but couldn't find him anywhere. So I went out onto the balcony, we live on the 25th floor, and found this man hanging over the edge by his fingertips. I went inside, got a hammer, and started hitting his hands. He fell, but landed in some bushes. So, I got the refrigerator and pushed it over the balcony and it crushed him. The strain of the act gave me a heart attack, and I died."

St. Peter couldn't deny that this was a pretty bad day, and since it was a crime of passion, he let the man in.

He then asked the next man in line about the day he died. "Well, sir, it was awful," said the second man. "I was doing aerobics on the balcony of my 26th floor apartment when I twisted my ankle and slipped over the edge. I managed to grab the balcony of the apartment below, but some maniac came out and started pounding on my fingers with a hammer. Luckily I landed in some bushes. But, then the guy dropped a refrigerator on me!"

St. Peter chuckled, let him into heaven and decided he could really start to enjoy this job.

"Tell me about the day you died?", he said to the third man in line.

"OK, picture this, I'm naked, hiding inside a refrigerator ..."

Prometheus from sources: ADM, Barclays Capital, Cazenove, Charles Stanley, HSBC, ING, SocGen, UBS.