Fed rate action commentary from Swiss Re Chief US economist

18 September 2007, New York

After today's decision by the Federal Reserve to lower the target fed funds rate 50 basis points to 4.75%, Swiss Re's Chief US economist, Kurt Karl, commented, "The Federal Reserve Board has taken strong action to alleviate the market turmoil. Since the market was hoping for 50 bp, this is a clear signal that the Fed is willing to provide liquidity and reduce market turbulence. At this time, however, the risk of a recession over the next 12 months is still 35% due to the weak growth, market turmoil and elevated oil prices. Slow growth should lower inflation further, so the Fed should have few concerns about inflation and is expected to continue cutting rates."

"The September US employment report precludes any optimistic scenario for the US economy — growth will be weak at best, or negative with a recession over the next 12 months. Because there are not a lot of built-up inventories or excess capital equipment, any recession is expected to be short and shallow. Equity markets, which are not highly overvalue, would rebound quickly. Credit markets, however, will continue to experience heightened volatility. The Fed is expected to lower the federal funds rate to 4.5% by year-end. This will support real GDP growth of 2% to 2.5% next year, but inflation will decline modestly and the yield on the 10-year Treasury note will be 4.0% to 4.5% by end-2007, rising to 4.75% by end-2008 as the economy strengthens. Under the recession scenario, the Fed cuts rates ultimately to 3.0% or lower, real GDP growth is about 1% next year, inflation approaches 1% and the yield on the T-note is 4.0% by end-2007 and 4.5% by end-2008, if not lower in both years," Karl said.

"Global growth remains firm, despite the many problems in the US. Euroland growth is fairly strong and the UK economy continues to perform well. However, the weakness in the US is assumed to alleviate growth and inflation pressures in Europe so that both the European Central Bank (ECB) and the Bank of England cut rates once, by 25 basis points each, by year-end. Japan's growth may be slowing and its inflation low, but the Bank of Japan is still expected to raise rates one more time this year, to 0.75%, and next year to 1.25% by end-2008. China continues to boom, so is expected to allow the renminbi to appreciate by about 6% per year, which will help to slow growth and lower inflation. Inflation — and a possible hard-landing — is a rising concern in China. The huge US current account deficit implies the U.S. dollar will continue to weaken a bit more against the euro (to $1.40 by end-2007 and 2008) and quite a bit more against the yen (to 107 yen per dollar by end-2008)," added Karl.

Notes to editors

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