Fed rate action commentary from Swiss Re Chief US economist

11 December 2007, New York

After today's decision by the Federal Reserve to lower the target fed funds rate 25 basis points to 4.25%, Swiss Re's Chief US economist, Kurt Karl, commented, "It remains to be seen if the Federal Reserve Board's third cut will be sufficient to keep the economy from going into recession. Clearly, it will not immediately end the market turmoil, but it will help alleviate the credit crunch. The Fed keeps cutting due to the rising risk of recession. Currently, this risk is about 45% over the next 12 months due to the weak growth, market turbulence and elevated oil prices. The economy slowed sharply in the past few months, so inflation should continue to decline. Unfortunately, the economy continues to deteriorate, so this cut is unlikely to be the last."

"The latest housing, industrial production and consumer spending data indicate that real Gross Domestic Product (GDP) growth in the current quarter is likely to be negative. The third quarter GDP growth rate, revised up to 4.9% at an annual rate, is not consistent with the underlying growth of about 2%, so the current quarter will be flat to slightly negative. Recessions are often defined as two negative quarters in a row, which is why the risk of a recession is at least 45% (in fact, we may have entered recession already.) With this economic weakness, the Federal Reserve Board is expected to cut by 25 basis point at each of the next two Federal Open Market Committee (FOMC) meetings. The likelihood of further, or steeper, cuts is rising, but remains dependent on the incoming data. The US weakness is now spreading overseas, so inflation is not a risk and core inflation is expected to decline to 1.6% year-over-year (y-o-y) by next December, from 2.2% recently. Real GDP growth will be about 2% next year and the yield on the 10-year Treasury note will end this year close to 4.2% and near 4.5% end-2008," Karl said.

"Global growth has weakened, but the risk of recession outside the US remains very low. The euro area and Japan are currently slowing, but growth close to 1.5% is very likely. In the UK, growth is expected to slow to around 2% in 2008, below its long-term trend rate of 2.5%. Lower exports to the US, due to its soft economy and weak currency, coupled with some credit market turmoils, particularly in Europe, are moderating demand and reducing growth. Meanwhile, oil prices have kept up inflation pressures, keeping the European Central Bank (ECB) from lowering rates and delaying, until recently, a cut from the BoE. The BoE is expected to cut rates by another 50 bp, while the ECB is expected to cut rates by 25 bp, but this is less uncertain. In Japan, rate hikes will continue to be delayed, but not postponed indefinitely, a couple of 25 bp hikes are expected late next year. China's boom is projected to continue through next year at least, bolstering high commodity prices. Inflation is rising rapidly in China, increasing the risk of a hard-landing (a major slowdown in growth). The US dollar is stabilizing relative to the euro, pound and Canadian dollar, but will continue to depreciate against Asian currencies," added Karl.

Notes to editors

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