Hopes for economy boost by US rate cut

There were hopes that the global credit crunch which sparked the bank run on the Northern Rock would begin to ease today after a bigger-than-expected cut in interest rates in the US.

The half percentage point cut by the Federal Reserve was aimed at preventing a recession from being triggered across the Atlantic.

But it will have far reaching consequences across the world and should ease the pressure on many banks in the UK.

Stocks immediately rose in the US and financial experts predicted the UK market would also react “positively” to the news today.

But they also warned that while the Fed’s decision to slash the cost of borrowing would bring short-term benefits, it could sow the seeds of future problems.

Meanwhile recriminations over the Northern Rock crisis have begun after it was reported the Financial Services Authority had repeatedly urged the Bank of England to intervene in order to avert a crisis of confidence at the firm.

All eyes will now be on the Bank of England to see if it will cut interest rates. Its next decision is due in early October.

The Financial Times reports the FSA and senior banking executives had pressed the Bank to widen the types of collateral to include other, less liquid, assets it would accept when lending to financial institutions.

The newspaper says some Northern Rock executives believe the run could have been averted if the Bank had temporarily accepted other assets as collateral, just as the European Central Bank and Federal Reserve do.

Mervyn King, Governor of the Bank of England, will be questioned by MPs at the House of Commons Treasury Select Committee tomorrow.

Financial analyst Justin Urquhart Stewart, director of Seven Investment Management, said of the Fed’s decision: “It will certainly help to ease the whole credit situation not just in the UK but all over the world.

“This has not just been about Northern Rock. The global capitalist banking system has to have the confidence that it can lend money to each other again.

“I think that the markets will take this news very positively on the basis that the Bank of England will have to follow suit one way or another.”

The Fed reduced its target for the federal funds rate, the interest that banks charge each other, from 5.25% to 4.75%.

Although some investors hoped for a large rate cut, most were betting on a smaller quarter percentage cut in the federal funds rate.

Yesterday, Prime Minister Gordon Brown pledged that the Government was doing everything in its power to maintain economic stability.

His comments came the day after the Government guaranteed to underwrite savers’ deposits at Northern Rock.

The queues of worried investors waiting to withdraw their savings were sharply down yesterday after Chancellor Alistair Darling’s dramatic Monday night announcement.

In his first public comments since the crisis broke last week, Mr Brown said: “Everything that can be done will be done and is being done to maintain the stability of the economy.

“We are an economy that will continue to grow, continue to create jobs, continue to have low inflation. Everything that has been put in place in the last two days is designed to ensure that.”

The Financial Services Authority (FSA) said it was now looking at ways of strengthening the system of compensation for depositors in order to prevent any repeat of the catastrophic loss of confidence which hit Northern Rock.

In the markets there was a recovery in banking stocks as the Bank of England announced a £4.4 billion cash injection to ease the pressure on lending rates between banks.

Shares in Alliance & Leicester, which plummeted by 31% on Monday on a false rumour that it had applied to the Bank for emergency credit, recovered all their losses.

Northern Rock shares were also up, although they did not recover from the losses of Friday and Monday. Most analysts believe that it will be bought up by a rival bank.

Mr Darling, who held talks yesterday with the Bank and the FSA to assess the situation, confirmed similar support would be offered to any other bank hit by the turmoil caused by the collapse of the sub-prime mortgage lending market in the US.

“What we have offered to Northern Rock would be offered to any other bank that got into that difficulty, although, as I say, no other bank has approached the Bank of England,” he said.

Shadow chancellor George Osborne told BBC Radio 4’s PM that the last few days had shown “indecision” from the Government.

He called for new arrangements for consumer credit, banking supervision and deposit insurance, and warned that the Government’s offer of a guarantee to savers may have to remain in force until these were put in place.

A poll for today’s Times suggested that the Northern Rock affair has not shaken public confidence in the banking system.

An overwhelming majority of those questioned – 86% – said that they still had a great or moderate amount of confidence in their bank or building society to protect their savings.

Populus conducted the poll for The Times on Monday, the day when Mr Darling announced the Government would guarantee the deposits of savers in Northern Rock.