The gap between inter-bank rates and policy interest rates, a key index of liquidity shortages, is much lower than in the early stages of the credit crisis as central banks have succeeded in boosting liquidity. The bad news is that the crisis has moved to a new and more dangerous phase. Citigroup and Merrilll Lynch have announced huge losses and there are fears over the strength of the banking system and the wider effects of the global credit crisis. Bank capital has become a vital, scarce resource. New capital injected by Chinese and Middle Eastern investors is helpful, but confidence has fallen in the face of worsening recession fears.

US jobs rose only 18,000 in December, while falling retail sales and relentless housing weakness add to the gloom. Other figures signal a US slowdown ­ not a recession ­ but the alarm bells are sufficiently shrill to force the Administration and Congress towards a package of tax cuts. The Fed is supporting fiscal stimulus and is signalling further aggressive easing. Having already cut its key interest rate by 100 basis points since August (from 5.25% to 4.25%), the Fed announced on 22 January an emergency 75 basis points cut, to 3.50%. Further US rate cuts, to 3%, are expected later in 2008.

Rates Pressures for interest rate cuts are also building up outside the US, but the pace is more relaxed, because recession fears are less acute and inflation concerns have higher priority. The Bank of England has kept Bank Rate at 5.50%. A cut to 5.25% is widely expected early in February, followed by a cut to 5% by May. The futures market signals further UK cuts to 4.25% or 4.50%, but, given sterling’s weakness and strong price pressures, cuts below 5% are too dangerous.

In the eurozone, with inflation above target at 3.1%, the ECB maintains a tough stance. The key ECB rate has been at 4% since June 2007. With growth set to slow, the ECB would probably cut its key rate to 3.75% by April. On the currency markets, the US dollar remains under pressure. But sterling is vulnerable to sharp speculative attacks.