16 May 2001

U.S. Federal Reserve Board Cuts Rates for Fifth Time 

The US central bank, the Federal Reserve Board, has again lowered short-term interest rates by 0.5 per cent, the fifth time it has done so this year in an almost unprecedented run of reductions. Hong Kong is sure to follow from Monday next, but what impact will the latest rate cut have. Our Chief Economist gives his views.

What do interest rate cuts matter if few want to borrow? Alternatively, what amount of interest rate cuts will make people want to borrow? These are important questions for the Hong Kong SAR in the wake of the US Federal Reserve Board's fifth rate cut this year of 0.5 per cent on Tuesday (US time), 15 May 2001.

Hong Kong's Banks will definitely follow from Monday, 21 May 2001 (with the announcement due on Friday, 18 May 2001). The Hong Kong stock market contributed its usual, immediate, knee-jerk reaction to the latest rate cut by rising some 300 points on Wednesday, 16 May 2001, despite the lacklustre reaction in the US equity markets.

But what will the latest rate cut mean to the broader economy? Like the other cuts made this year it is a move in the right direction for Hong Kong and reduces both the nominal and real costs of borrowing money. Yet the previous rate cuts have done little to increase lending in Hong Kong. When will the cumulative effect of the really quite dramatic rate cuts this year begin to kick-in?

This is not an easy question to answer. Despite the nominal rate cuts so far this year, real interest rates in Hong Kong (after taking account of continuing deflation) remain relatively high by the standards of recent history. Anyone borrowing for investment purposes therefore needs a good real return to justify borrowing in Hong Kong dollars from the local banking system. The discounts being offered on the local best lending rate (BLR) for new mortgage loans serves to emphasise this fact. Even these discounted mortgage rates have hardly helped business much for the banks.

Lower over interest rates since the beginning of the year hardly seemed to have helped overall confidence in the face of lower economic growth and uncertainties about the medium term outlook. There are clearly other factors than lower (nominal and real) interest rates affecting the willingness investors and consumers to borrow. At some stage this year, the impact of lower interest rates will kick in and the economic impact will be more evidently positive than is currently apparent.

In our last comment on this issue, delivered on 23 April this year after the previous US interest rate cut, we said: "Thanks Mr Greenspan, but can we have some more?" Mr Greenspan (the US Federal Reserve Chairman) and his colleagues on the Board have delivered - and the further cut is welcome -  but for the Hong Kong SAR, more would still be welcome.

With the US economic performance still mixed and the outlook still uncertain, he and his colleagues have indicated they could well oblige. In its statement announcing the US rate cut, the Federal Reserve Board said members continued to believe that the risks in the US are "weighted mainly toward conditions that may generate economic weakness in the foreseeable future".

The statement said of the US economy: "A significant reduction in excess inventories seems well advanced. Consumption and housing expenditures have held up reasonably well, though activity in these areas has flattened recently. Investment in capital equipment, however, has continued to decline.

"The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward. This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy".

The Board remained positive that inflation would remain under control. It said: "With pressures on labor and product markets easing, inflation is expected to remain contained. Although measured productivity growth stalled in the first quarter, the impressive underlying rate of increase that developed in recent years appears to be largely intact, supporting longer-term prospects.

"The Committee continues to believe that against the background of its long-run goals of price stability and sustainable economic growth and of the information currently available, the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

For further information, contact Ian K Perkin on 2823-1242.