The US Central Bank, The Federal Reserve Board, cut short term official interest rates by another 0.25 per cent (25 basis points) on Wednesday June 27 and Hong Kong deposit rates with some local banks have now also been reduced by varying amounts.

In a break with past practice and in recognition of the total deregulation of local deposit rates from July 3, the Hong Kong Association of Banks (HKAB), on Friday declined to move the "at call" deposit rate from the previous 2.25 per cent.

However, several of the largest banks moved immediately to adjust their own interest rates as of the start of business on July 3 (July 1 being a holiday and July 2 being the last day of regulation) in line with the new fully deregulated interest rate policy.

After the HKAB meeting, the Hong Kong Bank said it would cut its basic savings interest rate by a full 0.5 per cent to 1.75 per cent and the prime, or best lending rate by 0.25 per cent to 6.75 per cent, thus adding to its theoretical interest rate margin.

Bank of China on the other hand cut both its savings rate and best lending rate by 0.25 per cent, in line with the US move to 2 per cent and 6.75 per cent respectively

The rate policy across the rest of the banking system is likely to be uneven because of the final deregulation of interest rates, which leaves banks free to set their own "at call" deposit rates from that day. Other rates have been deregulated for some time.

The setting of deposit rates will now be done competitively with the rates being charged likely to differ in accord with the need for individual banks to attract of retain deposit funds.

The decision by the US Federal Reserve Board's Federal Open Market Committee (FMOC) on June 27 came as no surprise. The only question before the cut announcement was not whether there would be one, but whether it would 0.25 or 0.5 per cent.

The fact that the Fed cut rates by 0.25 per cent hardly serves to clear up uncertainties about the likely immediate direction of the US economy, however, as it suggests even the US central bank is a little unsure about the right policy stance.

On the one hand, the 0.25 per cent reduction in rates indicates the Fed believes that the economy is weak enough to require further monetary stimulus.

On the other, the fact that the Fed did not come in with a larger 0.5 per cent cut - as it has done on the five previous occasions it has cut rates this year - suggests there are also some positive economic signs in the US.

This no doubt reflects the mixed signals coming from the US economic numbers with some very great weaknesses, in industrial production, for example, but also some continuing strengths, as in the levels of consumer confidence.

It also helps explain the lukewarm reception the Fed's decision received on US equity markets, although the US bond (fixed interest) market did react positively.

What the reversion to a more cautious 0.25 per cent does also indicate, however, is that the Fed is giving itself some greater flexibility as far as future cuts are concerned. But it also suggests the current, six-month old, round of rate cuts is near its end.

For Hong Kong, another local rate cut is positive for the investment and wider economic outlook, but not as positive as a 0.5 per cent cut would have been.

The Hong Kong SAR is still experiencing deflation, which means that the real cost of borrowing money is still high by recent historic standards, although it has come down from its peak levels during last year.

It is therefore a case of "every little bit helps" as far as Hong Kong is concerned, although a further 0.25 per cent cut is likely to do little to boost local confidence, especially if it means that further cuts become less likely.

The situation is further confused because local banks will be free to go their own way on setting all deposit (and, of course, lending) rates from July 3. The chief consideration in rate setting will now be competition and the funding needs of individual banks.

On the other hand, any indication that the US economy is going to avoid recession and bottom out in the middle months of this year, would be positive for Hong Kong - indeed, far more positive that a 0.25 per cent rate cut itself.

In its own assessment of the US economy, issued when announcing the latest rate cut, the Federal reserve noted the slow down in some sectors of the US economy, but also stressed that inflation was being contained.

On balance, it added, that it was still more worried about the prospects for future economic weakness than it was about the prospects for the re-emergence of inflation, despite some signs that US inflation has increased in recent months.

"The Federal Open Market Committee at its meeting today decided to lower its target for the federal funds rate by 25 basis points to 3-3/4 percent," it said.

"In a related action, the Board of Governors approved a 25 basis point reduction in the discount rate to 3-1/4 percent.

"Today's action by the FOMC brings the decline in the target federal funds rate since the beginning of the year to 275 basis points," the Fed said.

Referring to the economic trends, it added: "The patterns evident in recent months - declining profitability and business capital spending, weak expansion of consumption, and slowing growth abroad -continue to weigh on the economy.

"The associated easing of pressures on labour and product markets are expected to keep inflation contained."

The Fed said that the continuing favorable trends bolstered long-term prospects for both productivity growth and economic expansion.

However, it added that taking into account its long-run goals of price stability and sustainable economic growth and based on the information currently available, "the risks are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."

ENDS