Another Fed rate cut on the way?

KPaul Donovan of UBS joins CNN to discuss the anticipation surrounding a Federal interest rate cut

A: The Fed has got to cut rates , there’s no question.

B: How much?

A: Er.. I think what we need to see is er, a process of cutting rates, so it’s less about how much today and about the, the holding up the hope of more rate cuts to come, what I’m expecting is a quarter point of the Fed funds rate today. Er, half of a percent of the emergency discount rate that’s where banks go when they are in difficulties. But clearly, a statement which says more is going to come. Don’t worry, guys, we’ll keep on cutting.

B: And what’s their key focus right now, is it trying to get the banks to er… reduce their inter-bank lending rate, is that the key focus right now?

A: That’s part of the process. Er… but it’s slightly wider than that , because of course what you’ve got at the moment is actually a monetary policy tightening. You’re a consumer, your interest rate hasn’t come down 3 quarters of a point along with the Fed funds rate. If you are a consumer, the chances are your interest rate's gone up because banks are tightening credit standards, and raising the cost that they pass on to the consumer. So what the Fed is concerned to do is to stop that process of monetary policy tightening.

B: And whatever the rates are , the other problem is the fact that the banks are just reducing their lending generally, and they don’t wanna lend to anyone with any sort of risky background, so that's gonna cause problem within itself. There is nothing the Fed can do about that, is there?

A: No, there is not much that the Fed can do about that. Er…, at the margin, we are, I think going to less credit, now, I’m, we can go back to Japan in the, in the 1990s, it doesn’t matter how much you cut rates. You cannot force banks to lend if they don’t want to. But in actual fact, one of the things that we’re concerned about is not so much new borrowers, but existing borrowers who’ve got adjustable rate debt er… where the interest rates go up and down, those are the guys who are vulnerable in this current environment, and the Fed's got to try and limit the damage to them. Because of course there are far more existing borrowers than there are potential new borrowers.

B: And you mentioned that the discount er.. rates which is the rate that the, you say that the banks go to the Feds asking for money if they really need it. Er… but that’s kind of epidemic, isn’t it? Because once people start using or once banks start using that facility, there is a huge stigma attached to that , so they are gonna avoid that , anyway, aren’ they?

A: Well, there is a stigma, and particularly here in the United Kingdom, er…borrowing from the Bank of England attaches a huge stigma. In the States it will…

B: Northern Rock was the classic example.

A: Precisely. In the United States it’s less so, and there has been more willingness to borrow from the discount window er in the United States. So,er…I think actually as the credits crisis of confidence continues, banks will get over the social stigma and recognize that, hold on, if here's someone prepared to lend his money. We might as well take advantage of it, and that will then help to at least smooth over some of the problems in the market...


smooth over: To mitigate or alleviate

discount rate: The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility--the discount window.