/www.bloomberg.com/ By Iain Rogers
London, Nov. 4 (Bloomberg) -- The Federal Reserve, Bank of England and European Central Bank are prepared to lower interest rates for the first time this year amid a convergence of economic data pointing to rising unemployment, declining confidence among consumers and executives and little prospect of faster inflation.
In the financial futures market, speculators are signaling a quarter percentage point cut in the overnight cost of borrowing between U.S. banks, to 1.5 percent. Futures trading also suggests a quarter-point cut by the ECB, to 3 percent, and a reduction of the same size by U.K. policy makers, to 3.75 percent.
``As recently as 10 days ago, no one thought any of the three central banks would cut rates,'' said Andrew Milligan, head of global strategy at Standard Life Investments in Edinburgh, which manages about $124 billion. ``Positions have shifted.''
That's because of mounting evidence the global economy is slowing. Governments in France and the U.S. reported last week that unemployment rose while U.S. consumer confidence, the most closely watched measure this year of economic health, plunged to a nine-year low in October. German business leaders were more pessimistic last month than at any time since January.
Alan Greenspan and the 11 other voting members of the Fed's policy panel will probably trim borrowing costs when they meet Wednesday, Fed funds futures contracts due this month indicate. In June, the yield was as high as 2.27 percent, showing investors expected a half-point increase.
Change in Outlook
Twenty-one of 22 primary dealers, firms that trade directly with the Fed, predicted a reduction in the target for overnight loans between banks Wednesday, a Bloomberg News survey showed. Bear, Stearns & Co. is the only firm forecasting no change. Two months ago, only eight forecast a cut this year.
The Bank of England and the ECB are likely to cut by a quarter point before the end of the year, and some economists said they may do so as soon as Thursday, when their policy makers convene. In July, futures showed investors expected Europe's main central banks would raise borrowing costs.
The Fed, ECB and Bank of England trimmed interest rates a total of 22 times last year to revive growth. Even with borrowing costs at the lowest level in four decades, retailers such as Federated Department Stores Inc., the owner of Macy's, are heading into the worst holiday season in a decade.
``There's concern central banks are only catching up with the situation,'' said Gary Dugan, head of global equity market strategy at J.P. Morgan Fleming Asset Management in London, which manages about $550 billion. Lowering borrowing costs ``may only be enough to hold the economy at this level,'' he said.
Slowing Growth
The European Union's economy will probably grow 1.1 percent this year, less than half the average pace of expansion in the past decade, while Japan's economy is likely to contract for a second consecutive year, according to International Monetary Fund forecasts. The U.S. economy will expand 2.2 percent, a percentage point below its 10-year average, the IMF said.
``We would view it as unambiguously good if the Fed lowered the interest rate again,'' said Van Jolissaint, chief economist at DaimlerChrysler AG's Chrysler unit. ``There is a risk of the economy stalling.''
Inflation is in check. Consumer prices in the U.S. rose 1.5 percent in September from a year ago. U.K. inflation has been below the central bank's 2.5 percent-limit every month except two since March 1999. In the dozen nations sharing the euro, prices climbed 2.2 percent in October from a year earlier, down from a peak of 3.3 percent in May last year.
Stock Markets
Stock markets have been falling for a third straight year for the first time since World War II. The S&P 500 Index has dropped 21 percent this year. Germany's benchmark DAX Index has slumped 35.5 percent, the worst performance among major global stock indexes, even after a 5.1 percent gain today.
In U.S. equity markets, stocks rose as some investors anticipated a rate cut by the Fed. The S&P 500 climbed 7.39 points, or 0.8 percent, to close at 908.35. The Dow Jones Industrial Average gained 53.96 points, or 0.6 percent, to close at 8571.60.
Not everyone is convinced lower rates will help global economies.
Japan's economy, mired in a 12-year slump, shows no signs of recovery even after its central bank lowered borrowing costs almost to zero in March 2001.
Borrowing costs have increased for many European companies in recent months, even with central banks holding rates close to the lowest levels since the Cuban missile crisis.
Investors have demanded higher rates of interest because of concern about record default levels this year, following the collapse of Enron Corp. and WorldCom Inc. Twenty European borrowers defaulted on debt worth $8.7 billion in the first nine months, according to credit rating company Standard & Poor's.
Congressional Elections
European carmakers need to pay almost 2 percentage points more on debt than their governments, compared with 1 percentage point at the end of last year, according to Merrill Lynch & Co. The yield spread for European phone companies has also reached 2 percentage points, up from 1.26 points at the end of 2001.
A majority of the 127 economists surveyed by Bloomberg News on Friday predicted the Fed will reduce its benchmark rate by a quarter-point to 1.5 percent. The decision will be announced the day after congressional elections in the U.S.
The Fed hasn't avoided rate changes around elections. In late 1998, after Russia's default and devaluation threatened the stability of financial markets, policy makers lowered borrowing costs in three quarter-point steps in two months. The second of those reductions was on Oct. 15, less than three weeks before congressional elections.
Economists Divided
In 1992, the Fed cut rates three times. The third time was on Sept. 4, two months before Bill Clinton was elected president, defeating George H.W. Bush, father of the current president.
Economists were divided on whether the two European banks will cut this week, or when their policy makers next convene in December. ``We expect the ECB to match whatever the Fed does,'' said David Mackie, an economist at J.P. Morgan Chase & Co.
The implied yield on the three-month euribor interest-rate futures contract maturing in December was 3.03 percent at 2:20 p.m. London time, 22 basis points below the ECB's benchmark rate. A basis point is 0.01 percentage point. The yield on the Libor contract due next month was 3.81 percent, compared with the Bank of England's base rate of 4 percent.
On the fed funds futures contract for December, the implied yield was unchanged at 1.40 percent, 35 basis points below the Federal Reserve's target rate.
A rate reduction may bolster consumer spending. U.S. mortgage rates have fallen in anticipation of a cut by the Fed, said David Berson, chief economist at Fannie Mae, the largest buyer of home mortgages in the U.S.
Mortgage Rates
The average rate on a 30-year fixed mortgage fell 18 basis points last week, to 6.13 percent. That puts the average payment on a $100,000 loan, including principal and interest, at $608, compared with $629 a year ago, when the rate was 6.45 percent.
Inflation-adjusted mortgage rates are little different today than they were when they peaked in mid-2000. In May of that year, the 30-year fixed rate was at 8.64 percent, and the inflation rate was 3.8 percent. That put the real mortgage rate at 4.84 percent, compared with 4.63 percent at the end of last week.
A quarter-point reduction in the Bank of England's base rate would save a homeowner with a 100,000-pound ($157,000) variable- rate mortgage about 15 pounds a month, according to HBOS Plc, the U.K.'s biggest mortgage lender.
The ECB, which sets borrowing costs for the dozen nations sharing the euro, pared rates four times last year, compared with the Fed's 11 cuts and the Bank of England's seven. The Fed last reduced rates on Dec. 11. Bank of England policy makers most recently trimmed U.K. borrowing costs in November 2001.